What does it mean that bitcoin is legal tender in El Salvador

What does it mean that bitcoin is legal tender in El Salvador
What does it mean that bitcoin is legal tender in El Salvador

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The Republic of El Salvador became the first state in the world to legal tender bitcoin. On Tuesday night, the parliament of the Central American country approved with 62 votes out of 84 the proposal of President Nayib Bukele, announced by himself last weekend with a video shown at the Bitcoin 2021 conference, a global gathering of prominent personalities in the world of cryptocurrencies held this year in Miami.

The law will come into force 90 days after publication in the official gazette and represents an unprecedented monetary experiment, which could have very important implications both on the fate of bitcoin and on the economy of the country, where currently the legal currency is the US dollar. . The latter will in any case keep its legal tender and will be the reference currency for the reporting of the financial statements. In short, El Salvador will have two currencies.

Giving legal tender to a currency means making it mandatory to accept it as a means of payment. The passed law contains this imposition, while excluding those who do not have access to the technology needed to accept cryptocurrency. It also provides that all outstanding dollar-denominated debts can be settled in bitcoin and gives taxpayers the ability to pay taxes in bitcoin. Furthermore, it stipulates that the price of any product or service can be expressed in bitcoin, which will make the cryptocurrency an official unit of account in the country (although given the current strong volatility of the price of bitcoin against the dollar at the moment it’s hard for any merchant to want to price their products in cryptocurrency).

With this law, the state of El Salvador then undertakes to guarantee its residents the automatic and instant conversion between bitcoin and dollars, so that anyone who receives bitcoins as payment can convert them immediately into dollars (thus avoiding the risk that the sum obtained in bitcoin loses value, in the event that the price of bitcoin in dollars drops very quickly immediately after the transaction), or vice versa.

The reasons for the proposal that became law are numerous.

First of all, it should be known that a large part of the income of the Republic of El Salvador is made up of remittances from emigrated citizens, that is, from the money that Salvadoran emigrants send to their families at home from the countries they moved to to support them economically. To get an idea of ​​the magnitude of the phenomenon: El Salvador has 6.5 million inhabitants and an annual gross domestic product of 27 billion dollars; Salvadoran emigrants around the world (which in the United States alone number 2.2 million, a third of those left at home) send around 6 billion dollars to the country every year, a figure that represents 22 percent of GDP: more than a fifth . It is estimated that around one third of Salvadoran families receive such financial support.

These international transactions are very expensive: commissions can be as high as 20 percent of the amount sent. This means that hundreds of millions of dollars a year end up in the coffers of intermediaries instead of reaching families who obviously need them. The president of El Salvador argues that giving emigrants the ability to transfer these funds in bitcoin will lower transaction costs, leaving more money available to families in need.

This may be true at the moment, but it must be taken into account that commissions are also paid to transfer bitcoins and that these are very variable. THE miners, that is, those who endorse bitcoin transactions also earn through a commission and prioritize transactions that offer a higher commission. In moments of heavy network congestion, that is when many transaction requests arrive in a short period of time, this mechanism causes the commissions to rise with the same waiting time (they do not depend on the amount sent). At the moment, however, sending any amount of bitcoin in an hour costs around a dollar, while if you wait 24 hours it will cost around 13 cents. So what the president of El Salvador is saying now makes sense, unless you want to send very low sums very quickly.

A second reason for giving bitcoin legal tender is related to monetary policy reasons. El Salvador is what is called a dollarized economy, that is, a state that has decided to adopt the dollar as its legal currency. In 2001, El Salvador replaced the Salvadoran colòn with the dollar after pegging it to its value for seven years (pegging one’s currency to another means ensuring citizens a fixed exchange rate between the two).

The decision to tie one’s currency to the dollar, to flank it or even to replace it, is usually taken after a major economic crisis followed by hyperinflation, that is, by a very strong increase in prices in the short term. Hyperinflation makes the value of the local currency very unstable, which therefore can no longer be used as a medium of exchange because people do not trust to accept it in exchange for goods or services. Therefore the government finds itself forced to use a more credible currency, the value of which is relatively stable.

However, this was not the case in El Salvador, which after the civil war ended in 1992 managed to control its inflation, and from 1993 to 2000 it grew its GDP by 4.4 per cent per year on average. The government of El Salvador chose dollarization for different reasons: it wanted to attract investments from the United States, and thought it would attract more if it eliminated the exchange risk for investors by replacing its currency with the dollar. The plan did not work, because to attract investors to a country it is not enough to use their own currency: social stability is also needed, which El Salvador could not offer given its high crime rate.

– Read also: Photo from the Apanteos prison in El Salvador

Even as a result of the failure of this plan, the country’s economic growth has changed little since then (from 1.1 percent in 2000 to 2.4 percent in 2019). And in addition to not having had the desired effects, dollarization has deprived El Salvador of its monetary sovereignty, that is, the ability to influence the economy by deciding how much money to put into circulation.

To make a country’s economy grow, a government has two tools: fiscal policy (i.e. the determination of taxes and public spending) and monetary policy. El Salvador has given up on the second: using only the dollar, the country must accept the monetary policies dictated by the central bank of the United States, the FED, which are decided with objectives that do not take into account the Salvadoran economy at all. This poses a risk to the Bukele government, especially at this historic moment.

In fact, in the last period, to alleviate the economic crisis due to the pandemic in the United States, the FED has put into circulation quantities of dollars never seen before. This (along with other factors) is driving up inflation not only in the United States, but also in El Salvador, where prices rose 2.79 percent in April compared to the same month a year ago.

– Read also: Because inflation is going up

Here is Bukele’s idea: to depend less on the Fed by placing bitcoin alongside the dollar, the issue of which is not linked to the decisions of the central bank of a foreign country, but occurs at a speed predetermined by an algorithm (therefore predictable) and decreasing in the time. Furthermore, the number of bitcoins is predefined: it will reach a maximum of 21 million bitcoins in the year 2140, when all are mined. This differentiates it from any other traditional currency, which can be printed at will by a central bank.

However, being less dependent on the Fed does not mean having monetary sovereignty. With this law, Bukele’s government still does not have a monetary policy tool with which to regulate the amount of money circulating in the economy. This remains a risk: if (very hypothetically) the Fed reverses its policy and takes dollars out of circulation in massive amounts and at the same time the value of bitcoin continues to rise as it has since its creation, the country could experience deflation (i.e. a lowering of prices) over which he would have no control. This could curb consumption (because when there is deflation, people tend to postpone their purchases, hoping to pay for them less in the future) and trigger a crisis.

The operation therefore does not eliminate the risks that the country runs by not having monetary sovereignty: let’s say that it mitigates them.

Likely, Bukele plans to offset these risks with the opportunities the law could generate. In addition to legal tender for bitcoin, Bukele’s plan is to make El Salvador a kind of paradise for companies and investors active in the cryptocurrency industry. In a recent tweet, the president actually listed a number of reasons why these people and companies should move their businesses to the small Pacific coast country: great weather, perfect surfing beaches, no property taxes, no taxes. earnings from bitcoin since it will be fiat currency and a promise of permanent and immediate residency to entrepreneurs in the sector.

In short, with this law, the government hopes to increase the money arriving from emigrants, reduce its dependence on the Fed and start an ecosystem that attracts investors and businesses (with their capital) to the country. As for bitcoin, the law creates a precedent that could be emulated by other countries in similar situations if it yields the desired results in El Salvador. This would have the effect of widening the catchment area of ​​this technology, also consolidating its reputation. Since the news of the passage of the law, the price of bitcoin in dollars has risen by 3.7 percent.

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