Last week, Nayib Bukele, the President of El Salvador, announced a plan to make bitcoin legal tender. The big announcement came via video on the second day of the Bitcoin 2021 conference in Miami.
Leading up to the big reveal, Jack Mallers, the founder of crypto payments company Strike, strode back and forth across the stage at the conference, wearing a baseball cap and hoodie. While flashing what looked like a diamond studded ring on his finger, he spoke of the woes of the unbanked and the tyranny of central banks. He then went on to play Bukele’s video to a crowd of thousands of bitcoiners.
Days later, Bukele pushed through his legislation, and on June 8, the tiny Central American country adopted bitcoin as legal tender. Alongside the US dollar, which the country transitioned to in 2001, businesses now must accept bitcoin as payment — unless they don’t have the technology.
El Salvador has partnered with Strike, a mobile app launched in March, to make payments in bitcoin possible. Strike claims it will allow Salvadorans living abroad to send money home instantaneously, without fees. Remittances, a lifeline to the country, surpassed $5.6 billion in 2019.
While the concept sounds ideal, a closer look reveals worrisome details: Bukele’s plan, it appears, is to confiscate US dollars from remittances and force people to accept a worthless dollar substitute through the Strike app.
In a Medium post written in January, Mallers claims that with Strike, “El Salvador users not only get access to free and instant international transfers anywhere in the world, but they also get access to a synthetic digital dollar on their smartphone.”
Those “synthetic dollars” Mallers is talking about? Those are tethers.
Tether, for the uninitiated, is the dubiously backed stablecoin recently ousted from New York after the New York attorney generally brought up allegations of fraud. There are currently 63 billion tethers in existence, with billions more being minted each month. Each tether is supposed to be worth $1, but nobody knows for sure what, if anything, is backing the dollar-pegged cryptocurrency. Tether, by its own admission, is only backed by 3% cash.
Strike uses a proprietary version of the Lightning Network, a second layer bitcoin solution for payments. The Lightning Network has never lived up to promises, and is not suitable for payments on a grand scale. Brazilian computer scientist Jorge Stolfi details its shortcomings in a Reddit post.
Here’s how Strike works: Say you want to send $1,000 from Los Angeles to your mom back home in El Salvador. You deposit your hard-earned cash into your Strike account. Strike debits your account and converts your $1,000 into bitcoins. It then sends the bitcoin to El Salvador where “it arrives in less than a second” on the wings of the Lightning Network.
Once your bitcoin crosses the border, Strike converts it into tethers and plunks those into your mom’s Strike account. Now, instead of sending your mom real dollars, which she needs to pay bills and buy food, you have just sent her a bundle of tethers. What can she do with them?
She can use them to buy bitcoin and then she can sell the bitcoin for cash. If that sounds like a lot of extra layers, well, yes. Mallers explains how it’s done. Your mom can “simply go to a Bitcoin ATM or local Bitcoin teller and receive their local fiat currency” — in other words, actual US dollars.
Let’s ignore for now the fact that there are only two bitcoin ATMs in the entire country of El Salvador — one in El Sunzal and the other in El Zonte — according to CoinATMRadar.
Anyhow, Mallers lays out the details:
- An El Salvador user requests to sell $100 worth of Bitcoin from Bitcoin ATM.
- El Salvador user scans the Bitcoin ATM QR code with their Strike app.
- Strike debits their Tether balance and converts it to bitcoin.
- Strike then sends the bitcoin to the desired Bitcoin ATM address.
- The ATM receives the bitcoin and issues the user their local fiat currency.
Essentially, you are converting back and forth to bitcoin twice. Here is the problem with that: Bitcoin is extremely volatile. The price can go up one day and down the next. On April 14, bitcoin hit a record of $64,829 but has since lost nearly half its value. How’s that for remittances?
“The FX risk in this system is massive,” Frances Coppola, a UK-based writer, who spent 17 years in banking, said in a tweet. “It’s not transaction fees people should be worrying about, it is the potential for massive USD losses because of the BTC conversion.”
FX, or foreign exchange, is the cost of converting from one currency to another. With bitcoin, that cost includes transaction fees — which were as high as $58 in April, according to YCharts — and the cost of bitcoin’s potential drop in value. (Conversely, if bitcoin goes up in value, Strike users won’t benefit because their money is converted dollar for dollar into tethers.)
Bukele has set aside a reserve fund of $150 million at the country’s development bank BANDESAL to guarantee these currency exchanges — so merchants using Strike for bitcoin payments will not have to suffer any loss in value.* The trust has been set up in partnership with Strike.
In a Twitter Spaces call with several bitcoiners, Bukele explained that the cash in the reserve fund will eventually be replaced with bitcoin. “We are going to provide those US dollars, but we are going to get bitcoin in exchange.”
As bitcoin skeptic David Gerard points out in a more elaborate story, this is an excellent way to launder filthy bitcoin.
“There is absolutely no way to run Know-Your-Customer to international standards on Bitcoin transactions, and also have Bitcoin treated like legal tender. So they’re setting up a gateway for questionable bitcoins,” he said.
What’s to come of all this? My guess is that the $150 million fund will be sucked dry in no time by bad actors. The actual acceptance of bitcoin for payments of any sort in the country will be negligible.
Tether will see some level of adoption as “synthetic dollars” in Strike accounts, but Salvadorans will soon learn it’s worthless when they can’t convert tethers to actual spendable dollars.
I would not be surprised if the Strike app suffers some major hack within six months. Also, I suspect international banks will severe ties with the local economy, meaning El Salvador’s economy will sink even further as a result.
Bukele, who was elected in 2019 from the center-right Grand Alliance for National Unity party, has joined Mallers and a host of other bitcoiners in adding laser eyes to his Twitter profile. He is now tweeting about his next big idea: a project to mine bitcoin using energy from one of El Salvador’s volcanoes.
*Update June 12: it appears the $150 million reserve fund is only there to protect merchants from the volatility of bitcoin, not regular users. I also added a link to the Twitter Spaces call where El Salvador’s president says the fund will ultimately be replaced by Bitcoin. (Sounds a bit like Tether’s reserves!)
Feature Image: Twitter
The curious case of Tether: a complete timeline of events
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