The private sector will face increased currency risks should Bitcoin become legal tender in a country. El Salvador’s experiment is being closely watched by the international financial community.
The recent Bitcoin Conference held in Miami has brought the world’s attention to the cryptocurrency space once again. Fans of Bitcoin from all over the world got together to discuss the next developments in blockchain, as well as what is the next step for Bitcoin.
One of the news stories that came out shortly after the conference ended was that El Salvador is considering making Bitcoin legal tender in the country, making it the first country in the world to adopt Bitcoin as legal tender.
The news quickly attracted cheering from Bitcoin fans such as Michael Saylor, the CEO of MicroStrategy, a company that converted its treasury from US dollars to Bitcoin and borrowed additional funds to purchase Bitcoin, and a word of caution from the International Monetary Fund (IMF). The IMF expressed its concerns about the financial, macroeconomic and legal issues faced by the proposal.
What about the currency risk?
Bitcoin – More than Ten Times Normal FX Volatility
Before looking at the currency risk that businesses need to embrace to cope with Bitcoin’s volatility, one needs to consider the current situation in El Salvador. The country does not have its own currency, but it is “dollarised”. Effectively, it means that the country “imports” the monetary conditions from the United States – but it cannot print dollars.
For businesses, the currency risk poses an extreme challenge. Imagine selling your goods and services and receiving Bitcoin as payment. From that moment, most businesses will want to hedge the currency risk, and they need to do so quite fast – Bitcoin is so volatile that one hour later, it may be up or down 10%, for example.
Therefore, the corporate sector would have a massive cost of hedging if Bitcoin would be used as a legal tender, not to mention that businesses would take additional currency risk. Solely from a currency risk perspective, the private sector would face an additional burden, regardless of the price of Bitcoin rising or falling.
Bitcoin has come a long way in the few years of its existence – from merely an idea to the most popular digital asset. El Salvador’s decision, in the words of Benoit Coere, a former ECB Executive Board member and the current Head of Innovation Hub at the Bank for International Settlement, is an “interesting experiment”. Successful or not, it remains to be seen.