Unless you’ve been living under a rock, you’ve probably heard of Bitcoin before. Bitcoin (₿; BTC) is currently a highly sought-after asset. It is a decentralized digital currency that can be sent from user to user on a peer-to-peer network without involving intermediaries. The transactions done are confirmed by network nodes using encryption and recorded in a blockchain which is a publicly distributed ledger.
What Has Happened?
El Salvador’s parliament passed the proposed law of making bitcoin a legal tender on June 9, 2021, after its President announced it a few days earlier. The new law will go into force in September and it will make El Salvador the first country to adopt a cryptocurrency formally.
Since 2001, when a right-wing government made the US dollar the official currency, El Salvador has not had its own monetary policy. As a result, El Salvador is currently one among the three nations in Latin America to have a “dollarized economy” along with Ecuador and Panama.
What Making Bitcoin A Legal Tender Implies?
Bitcoin usage is already legal in El Salvador, as it is in most Central American countries. So, before the law passed, if you wanted to pay for something in Bitcoins, you could do it if the recipient was ready to accept bitcoins as payment.
Making bitcoins legal tender makes it a requirement for the recipient to accept bitcoin necessarily. According to the new law, “every economic agent must accept Bitcoin as payment when presented by whoever acquires an item or service.” The country has even promised $30 in Bitcoin to each citizen who downloads and registers on the country’s new crypto wallet, Chivo.
Reactions On The Move
In general, it’s a piece of positive news for cryptocurrencies and their supporters. However, some crypto experts have criticized the move, claiming that El Salvador could have looked into other crypto options that would have worked better as a currency than Bitcoin, whose three transactions-per-second processing rate is deemed too slow compared to other virtual tenders such as Bitcoin Cash or Monero.
Then, some are entirely unhappy with having private cryptocurrencies as a legal tender and are pointing towards the absence of a centralized regulatory authority and other problems associated with this move, like the possibility of fraud and money laundering, high energy costs, and extreme volatility.
What About Other Countries?
Cryptocurrencies are quickly gaining traction in many countries globally beset by economic uncertainties, such as Cuba, Mexico, Venezuela, and Paraguay, where many prefer decentralized and unregulated virtual tokens.
Since Communist rule authorized the mobile internet in 2018, the attractiveness of cryptocurrencies has grown in Cuba, as many have used them to avoid US sanctions and a decades-long trade embargo.
The crypto market has increased significantly in Mexico, where remittances from the United States are a significant source of income. The country’s Bitso crypto exchange rose by 342% between September 2019 and May 2020. According to Reuters, Mexico’s third-richest person, Ricardo Salinas Pliego, has suggested that his bank, Banco Azteca, may soon accept Bitcoin. If that happens, it will be the country’s first bank to accept Bitcoin.
In Venezuela, which is experiencing an economic and humanitarian crisis, many people have turned to cryptocurrencies. It is because the Bolivar, which is the country’s official currency, has been weakened by hyperinflation.
On June 17, Carlos Rejala, a Paraguayan lawmaker, tweeted, “This is Paraguay. July we legislate! #Bitcoin,” flickering rumours that Paraguay may soon adopt Bitcoin as a legal tender.
Why Does El Salvador Want To Make Bitcoin A Legal Tender?
INCREASING EL SALVADOR’S GDP
Here’s a tweet by Bukele, made on June 6. This argument by him seems a bit convoluted and illogical based on the following facts. Market capitalization implies a listed company’s valuation based on multiplying the share price by the number of shares. For example, the $680 billion Bitcoin market capitalization represents the currency’s market value multiplied by the number of bitcoins created so far. For comparison, the market capitalization of Tether’s 63 billion coins in circulation is $63 billion.
Hence, it will be flawed to think Bitcoin’s total market value equals money that bitcoin owners around the globe are looking to invest anywhere. Most people buy bitcoins as an investment. Neither significant fund managers nor average punters holding bitcoins will likely suddenly want to start investing in El Salvador. On the other hand, foreign investment is not a component of GDP (which is the value of market transactions in an economy).
So, for example, foreigners using bitcoins to buy assets such as land in El Salvador would increase the price but not necessarily increase the GDP.
A rise in foreign investment into new infrastructure and firms enhances productive capacity and boosts GDP. Nonetheless, there’s no reason to believe that making Bitcoin legal tender will increase such foreign investment.
El Salvador could have made things easier by adopting a “stable-coin” with a guaranteed price of one US dollar, such as Tether, the third-largest cryptocurrency. But that would have been far less noteworthy, defeating the stated rationale of Bukele’s support for the move.
FACILITATING REMITTANCES
El Salvador, which has roughly 64 million people and an area slightly larger than Meghalaya, mainly relies on remittances sent by Salvadorans living overseas. Despite the effects of the pandemic, more than a quarter of the country’s citizens living in the United States sent home $6 billion+ in remittances in 2020, accounting for more than 20% of its GDP.
In response, Bukele stated that a significant portion of the $6 billion is lost to intermediaries. As a result of the use of Bitcoin, the collective amount received by over a million low-income households will increase by billions of dollars each year. Bukele also stated that Bitcoin would benefit from increased financial inclusion in El Salvador, where 70% of the population doesn’t have a bank account and relies on the informal economy.
While any cryptocurrency can well facilitate more efficient transfers without bank charges being imposed, the significance of remittances to the Salvadoran economy points to another issue. According to World Bank, El Salvador is an emerging country, with one of the lowest internet usage rates in the Americas – 33% in 2017. How many street hawkers, vendors, or farmers are equipped to handle transactions using cryptocurrency? Hence, US dollars is likely to remain the default currency.
The advantages of making Bitcoin legal tender are far from clear. Moreover, there are concerns that the broader use of Bitcoin will facilitate the black economy and make tax avoidance easier. So this might turn out to be a grand experiment that may eventually become a disastrous financial case study being taught to Economics and Finance students across the globe in a few years.
For the sake of El Salvador’s people, let’s hope it gets successful. But, unfortunately, the odds are that it is additional proof of Bitcoin’s unsuitability for usage as a currency, confirming that Bitcoin is nothing more than a speculative bet.
The Economic Effect, This Move May Lead To
El Salvador making this move isn’t as considerable as it would be for other nations globally because El Salvador is one of about a dozen countries that are very small and are counted as the microstates such as Andorra and Nauru.
In 2001, El Salvador abandoned its own currency, the “colon,” and accepted the US dollar as legal tender. Hence, these nations exist without their own currency or a common currency such as the Euro.
So El Salvador has very little to lose than other nations do in adopting a second currency as legal tender. Therefore, there won’t be any controversy about losing sovereignty and monetary policy autonomy. Monetary policy autonomy is defined as a central bank’s ability to conduct monetary policy in response to domestic economic situations (such as real GDP growth and inflation) without being tied to another country’s monetary policy. In countries with a significant population, governments must have autonomy over their financial system to respond to any economic situation accordingly.
Moreover, there will be no loss of “seigniorage” - the profit made on issuing currency that’s worth a lot more than the cost of making it.
But having two legal tenders will complicate matters, mainly when one of those currencies is subject to wild swings in its value. The kind of price volatility associated with cryptocurrencies isn’t something any government generally wants to see in a currency. Moreover, the fluctuations associated with Bitcoin signifies its weakness as a viable alternative to central bank currencies, making it suitable only for transactions you don’t want to be traced and as a speculative investment.
The new law states that “all obligations in money expressed in USD, existing before the effective date of this law, may be paid in bitcoin.” But that isn’t very easy. For example, how and by whom will the number of bitcoins necessary to pay a debt be determined? Will it be based on the Bitcoin price when the debt was incurred or when the debt falls due? The difference of even a few days could be considerable.
Why would you want to buy anything with Bitcoin if the price is expected to rise? Else, Why would you like to accept it at a lower price if the price is expected to fall? Hence, using US dollars will still make the most sense for the majority of transactions.
So making Bitcoin legal tender could result in destabilizing El Salvador’s economy.
What Is The Take Of IMF And World Bank?
Alejandro Zelaya, the Salvadoran finance minister, has requested technical support from the World Bank as the country aims to utilize bitcoin as an alternative legal tender alongside the US dollar. The World Bank responded by rejecting the plan, claiming that it cannot support El Salvador’s bitcoin deployment owing to environmental and transparency concerns.
The minister also stated that current talks with the International Monetary Fund had been fruitful. On the other hand, the IMF stated that the country’s acceptance of bitcoin poses “macroeconomic, financial, and legal concerns.” The IMF, according to Zelaya, is “not opposed” to bitcoin adoption, but the IMF did not reply to a request for comment.
Furthermore, a recent poll revealed that more than three-quarters of Salvadorans are dubious of the maverick leader’s attempt to embrace Bitcoin as an alternative legal tender.
What Is The Future Of Bitcoin?
Well, a lot of people are arguing over it now. Debates are going on between economic schools, between politicians, between programmers, between finance professionals. Some people are smart, while some are misinformed. Some people say it’ll change the world, while some say it’s just a fad.
In such a scenario, it would be best to wait, observe and form your opinions regarding the future of bitcoin.
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