El Salvador was challenged on the first day of the new Bitcoin law coming in effect. The Chivo Wallet — which allows consumers to purchase goods and services in Bitcoin — temporarily shut down. While a technical glitch can happen, the impact on Bitcoin was dramatic with a spillover to El Salvador bonds, which jumped and caused the yield curve to sharply invert. It was an unwelcome sign that a wide use of Bitcoin may have major implications for the Salvadoran economy and the government’s ability to pay interest on the debt.
Bitcoin is now a currency to El Salvador, and the country — if it so wishes — could use Bitcoin exclusively to purchase goods and services. But relying on Bitcoin for commerce means the economy would be subject to liquidity and volatility of Bitcoin that cannot be controlled with domestic monetary policy. It reminds of previous emerging market crises such as in Argentina and Venezuela, where a foreign currency (the U.S. dollar) dominated domestic activity to such an extent that a shortage of foreign currency could cause economic paralysis.
In the case of El Salvador, a wide adoption of Bitcoin is limited to the amount purchased by the Salvadoran government. Other central banks are following a different route. A recent initiative in the Asia Pacific to pilot a cross-border test of a central bank digital currency is a noteworthy alternative to El Salvador’s move to adopt Bitcoin as legal tender.
Australia announced it is participating together with the central banks of Malaysia, Singapore, and South Africa in “Project Dunbar” to develop prototype platforms to enhance international digital settlement of currencies and securities. Such platforms could enhance the speed of settlements and delivery of securities, currency, and commodities, thereby drastically lowering the transaction costs between financial institutions and intermediaries.
But such is not likely achieved without more volatility of Bitcoin and other crypto assets. The price swings indicate that the crypto market is trading with a much closer connection with physical and financial assets, as an expression that two worlds — crypto and global financial markets — are becoming increasingly interconnected.
The fact that El Salvador’s bonds were impacted by the change in the value of Bitcoin means that the financial system is moving faster to a reality of digital payments, transactions and issuance. But there are other reasons why the crypto universe is shaking. The boom in NFTs — non-fungible tokens — is sparking volatility in Ethereum gas prices, where gas fees for NFT-trading have hit a new high.
A sudden interest by crowds of “meme traders” for NFT has driven demand for Ethereum in high gear to enable NFT trading. As a result, the social sentiment ETF — BUZZ — is positively correlated with the Grayscale Ethereum Trust. Such correlations and connections between Bitcoin, crypto and financial assets did not exist before. The financial relationship between Bitcoin and El Salvador bonds, Ethereum gas prices and social sentiment stocks is strengthening because digital assets are rapidly embraced by institutional and retail investors as a compelling, alternative asset to diversify portfolios invested in conventional stocks and bonds. Yet, it is a logical output of a financial eco-system evolving into digitalization of markets that includes a fast growing, newly emerging digital derivatives industry.
For the near term, Bitcoin’s ability to rebound is not as stunning as before. Markets cannot ignore that crypto is a necessary means to transform existing trading technology to a next level.