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El Salvador’s Bitcoin Folly

Summary:
Many aspects of cryptocurrencies are baffling, not least the success of a joke like Dogecoin. But El Salvador’s recent adoption of Bitcoin as legal tender alongside the US dollar is perhaps the strangest and potentially most worrying example of all. CAMBRIDGE – El Salvador this month became the first country to adopt a cryptocurrency – in this case, Bitcoin – as legal tender. I say the first, because others might follow. But they should think twice, because the idea is highly dubious – and likely to be economically dangerous for developing countries in particular. Biden's Collaborative Containment Strategy CHRIS KLEPONIS/AFP via Getty Images

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Many aspects of cryptocurrencies are baffling, not least the success of a joke like Dogecoin. But El Salvador’s recent adoption of Bitcoin as legal tender alongside the US dollar is perhaps the strangest and potentially most worrying example of all.

CAMBRIDGE – El Salvador this month became the first country to adopt a cryptocurrency – in this case, Bitcoin – as legal tender. I say the first, because others might follow. But they should think twice, because the idea is highly dubious – and likely to be economically dangerous for developing countries in particular.

I will admit that I don’t understand the need for cryptocurrencies at all. Like many economists, I fail to see what problem they solve. They aren’t well designed to fulfill any of the classic functions of money – a unit of account, store of value, or means of payment – because their prices are so extraordinarily volatile. This volatility is not surprising, because cryptocurrencies are backed neither by reserves nor by the reputation of a well-established institution, such as a government or even a private bank or other trusted corporation.

In fact, Bitcoin and its fellow cryptocurrencies were born from an anarcho-libertarian distrust of central banks. True, many central banks, especially in developing countries, have a history of debasing their currencies. But adopting Bitcoin as legal tender makes little sense for El Salvador.

In 2001, El Salvador adopted the US dollar as legal tender to ensure the monetary stability that the country’s national currency, the colón, had historically failed to deliver. The reform worked: the country’s annual inflation rate, which had substantially exceeded 10% between 1977 and 1995, has declined markedly since the adoption of the dollar. It has been below 2% since 2012, and close to zero since 2015 – a rarity in Latin America.

Giving up the monetary independence afforded by issuing one’s own currency carries costs – particularly, the loss of the ability to adjust monetary policy in response to local economic conditions. El Salvador already accepted this when it adopted the dollar. The costs would be even greater if a currency as unstable as Bitcoin were the sole national...

Jeffrey Frankel
Jeffrey Frankel, a professor at Harvard University's Kennedy School of Government, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He directs the Program in International Finance and Macroeconomics at the US National Bureau of Economic Research, where he is a member of the Business Cycle Dating Committee, the official US arbiter of recession and recovery.

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