The Bankification of Bitcoin

El Salvador's experiment in cryptocurrency proves the dream of decentralized finance remains elusive

Salvadoran President Nayib Bukele. Photo by Jose Cabezas for Reuters.

Today, El Salvador inaugurated Bitcoin as an official currency for the South American country. Is Bitcoin ready for the job?

From the beginning, Bitcoin has set lofty expectations among crypto enthusiasts for the future of money. Coming online in the wake of the global financial crisis of 2008, the currency promised a peer-to-peer payment system controlled by the people, free from censorship and accessible by anyone with an Internet connection. 

More than a decade later, Jack Mallers, CEO of the Bitcoin payments startup Strike, employed this now-familiar—yet no less fervent—language when he revealed to an audience of thousands at the Bitcoin 2021 conference that Strike would be working in collaboration with the Salvadoran government to enable Bitcoin as a viable currency alternative to fiat. “We’re talking about Bitcoin for countries—and, in particular, the human freedom and financial inclusion that [it] brings,” he said, pacing across the stage. “[This is] one small step for Bitcoin, one giant leap for mankind.”

Later that week, in a Clubhouse hangout of over 20,000 listeners, Salvadoran president Nayib Bukele confirmed his administration’s intent to invest heavily in enabling Bitcoin payments in the country, outlining an ambitious plan for “every restaurant, every barber shop, every bank” to eventually be able to accept Bitcoin. The first step to this plan would take place the very next morning, when the legislative assembly of El Salvador passed the “Bitcoin law”, officially designating Bitcoin as legal tender in the country. Enacted on June 8, the law went into effect on September 7, giving El Salvador merely three months to realize Bukele’s vision.

So, is the future of money here?

In an industry infamous for its larger-than-life personalities and the brash claims they make (case in point, see: “crypto Twitter”), are Mallers and Bukele true visionaries? Could El Salvador really be the first to establish a peer-to-peer, censorship-resistant and widely accessible payment system? 

Unfortunately, it seems these hopes will be disappointed. Though details of El Salvador’s plans come September 7 are scarce, what we do know suggests that Bitcoin payments in the country will be processed primarily through a highly centralized and closely controlled system. At least for the moment, the dream of decentralized finance remains elusive.

Traditionally, financial systems have been defined by centralization. As individuals, we rely on institutions to do everything from store our savings to collect our taxes to validate our currency. During the Covid pandemic, the U.S. government coordinated the release of trillions of dollars in stimulus checks, each deposited directly to American taxpayers’ bank accounts. Centralization demonstrably provides a high degree of control—yet the potential abuse of this control, whether due to hacking or government corruption, remains a constant threat. 

In contrast, decentralized systems such as Bitcoin are much more robust against malicious behavior, since control of the network is distributed across many peers. Theoretically, the relationship between decentralization and tamper-resistance is linear: the more peers there are, the harder it is for a malicious party to gain control of the network. However, achieving a flat, peer-to-peer structure in a trustless environment has proven to be quite difficult in practice. Because peers require time to reach consensus on network state, highly decentralized systems are slow. Bitcoin can only process around 4.6 transactions per second, while Visa averages around 1,700. Imagine waiting around at a restaurant an hour after getting your check—and you’ll have a pretty good idea what it’s like to pay with Bitcoin. By committing to rolling out Bitcoin payments at scale by September, the Salvadoran government has found itself working on a tight deadline to solve a problem that has long limited Bitcoin’s utility as a currency.

So far, only two significant components of El Salvador’s Bitcoin infrastructure have been publicly disclosed. Mallers’ company, Strike, is one of them. The other is El Salvador’s official Bitcoin wallet, Chivo. Launched in El Salvador in March, Strike has since established itself as the most popular mobile app in the country. Meanwhile, Chivo is set to launch later this year. Of these two platforms, Strike has provided much more detail on its implementation––and it’s a good place to start off our discussion. Though the company is based in Chicago, Strike has maintained a close working relationship with the Salvadoran government. As the company’s CEO and founder, Mallers has been involved in the development of El Salvador’s Bitcoin program since its conception, from helping write the “Bitcoin law” to advising the effort to build crypto infrastructure in the country. Therefore, understanding Strike’s design and core value proposition might give us some perspective into the considerations shaping El Salvador’s Bitcoin ecosystem.

Strictly speaking, Strike isn’t a Bitcoin wallet. The app is described on its website as a “payments application” that “facilitates transactions over the Bitcoin/Lightning networks''. However, users aren’t assigned a Bitcoin address when they open a Strike account—and so never actually hold any Bitcoin on the platform. Instead, as Mallers has stated, in-app balances on Strike are always stored in fiat. Therefore, even though the app did recently enable purchasing Bitcoin and sending it to a third-party wallet, it’s clear that simply sending/receiving BTC is not the business Strike is in (although this may change in the future). So, how does the platform leverage the Bitcoin network? Understanding this requires us to examine the technical capabilities of Lightning.

Lightning is a Bitcoin scalability protocol developed in 2017 that allows a payer to open a transaction “channel” with a payee for a predetermined period of time. Liquidity—that is, how much money is available for payments on the channel—is determined by how much Bitcoin is “locked up” when the channel is opened. While a channel is open, the payer can send funds to the payee instantaneously and without transaction fees. After the channel expires, accounts are then settled on the Bitcoin network with just one transaction. In this way, Lightning provides a potential solution to both the speed and cost problems of paying with Bitcoin, at least when making regular payments to a single source (i.e. buying coffee or groceries).

However, Lightning comes with some serious drawbacks. In order for using Lightning to make economical sense, the liquidity of a given channel must be high enough to allow two or more commitment payments—otherwise, you should just save yourself the trouble and make the transactions directly on the Bitcoin network. However, this means that someone who wants to set up a Lightning channel to pay their rent would have to lock up enough value in the channel for the next few months’ payments. For anyone earning wages or living paycheck to paycheck, this frontloaded cost might be prohibitive to using Lightning. 

Additionally, Lightning users risk being defrauded if the party they are transacting with chooses to close the channel between them and pocket the funds. Since disputing a fraudulent channel close requires submitting yet another on-chain transaction, for low liquidity channels, where the potentially stolen funds might be less than the transaction fee required to challenge the channel close, it makes more sense to cut your losses—creating the untenable situation in which scammers are empowered to behave dishonestly with little risk of facing consequences.

Here, Strike steps in with its solution. When a Strike user sends money through the app, the amount is debited from their in-app balance in fiat. Then, depending on where these funds are being sent, the money may be converted to Bitcoin and the payment routed to its destination locale through Strike’s own set of privately maintained Lightning channels and nodes. Finally, the money is credited in the local fiat currency to the receiver. If two users in the same locale want to pay each other, the transaction can be carried out simply by updating each party’s in-app balance, without involving Lightning at all. In either case, users never need to concern themselves with either the technical challenges or costs of using Lightning.

Therefore, Strike’s core functionality might most accurately be described as an international money transfer solution. By essentially leveraging the Lightning network as a settlement layer for fiat currency exchange, Strike enables users to send money—instantly and with minimal fees—practically anywhere in the world. In fact, Strike’s effectiveness in processing international transactions may actually help explain its popularity in El Salvador. In a country where 24 percent of the country’s GDP comes from remittances, the ability to send money back home from abroad cheaply and conveniently is crucial to the average Salvadoran’s quality of life. Nevertheless, it’s also important to recognize the tradeoff Strike is making here. In spite of the app’s professed use of Lightning and Mallers’ passionately pro-Bitcoin rhetoric, Strike is a highly centralized payment system—not unlike a traditional financial institution. The platform certainly performs many of the same functions, from authenticating user credentials to tracking balances to abstracting away the complexities of interfacing with financial infrastructure to perform a transaction. In light of this, perhaps it’s not so surprising that Mallers himself describes Strike as a “Bitcoin neo-bank.” 

When we consider the promises being made about the other important piece of Bitcoin infrastructure in El Salvador—the country’s officially designated Bitcoin wallet—we begin to notice a pattern. Chivo will purportedly also offer features such as fee-less transactions and instant settlement. Though technical specifications about Chivo haven’t been released yet, we can be reasonably certain that in order to deliver on the features Bukele has promised—which, it is worth mentioning, Strike also offers—Chivo will need to operate a payment system similar to Strike’s. Perhaps our strongest signal on Chivo’s backend architecture comes from Bukele’s recent announcement that Chivo users will automatically receive $30 worth of BTC when they create an account. Coordinating the distribution of these funds requires privileged knowledge of when a new user joins the Chivo platform and the authorization to change their balance—both of which are telling signs of a centralized system.

Of course, those in El Salvador unwilling to rely on either Chivo or Strike for payment services are technically free to explore other options. Bukele has even said that Chivo will be interoperable with third-party wallets. However, Salvadorans who choose to go this route will need the technical expertise to contend with all of the problems with using Bitcoin that we’ve discussed—namely, its slow transaction speed and high technical learning curve—effectively capping the number of alternative wallet solutions we would expect to see. 

It’s important to understand: El Salvador’s effort doesn’t represent the first attempt to centralize Bitcoin in order to improve its usability as a currency. For years now, figuring out the best way to deliver a user experience on par with the one we’ve come to expect from a payment service has been a top priority for any crypto-focused company. Up to this point, such considerations have usually led to centralized solutions. As one of the biggest players in the blockchain space, Coinbase has taken a very similar approach to Strike and Chivo, providing users with an intentionally bank-like experience for crypto investing—while promising to “increase economic freedom in the world.” Placed in this context, Mallers’ and Bukele’s shared vision for Bitcoin seems to find a natural precedent. However, what sets El Salvador’s situation apart is that this is the first time a sovereign nation has stepped in to “bankify” a cryptocurrency. The implications this has on the economic freedom in the country are as yet unknown. However, if El Salvador’s plans have the effect of rounding up control of the finances of its citizens on a limited number of government-sanctioned platforms—with few competing alternatives available—it arguably calls into question the very premise that adopting Bitcoin will prove advantageous for Salvadorans.

So, it’s probably safe to say that El Salvador hasn’t managed to crack Bitcoin’s hardest problems in the last three months. What we know about the country’s Bitcoin payment platforms suggests that there is very little distinguishing these institutions from traditional banks. However, what is arguably more important now is whether El Salvador’s plan will even work. Whether they intended to or not, Mallers and Bukele have placed a high-profile bet on Bitcoin—and, by extension, the future of all digital money. The outcome of El Salvador’s experiment with Bitcoin will likely have a far-reaching—if complicated—impact on the field of digital asset development. Success in El Salvador will demonstrate the viability of a digital currency, but will likely also set the precedent for governments to centralize crypto. On the other hand, if El Salvador’s program is a failure, it may be chalked up as proof that crypto is unsuited for use as currency, but will also give this field more time to refine the technology to be capable of truly revolutionizing our monetary system. For now, the question we should ask is: “What are the essential features of money?” Only time will tell if El Salvador’s answer is an adequate one.

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