El Salvador Makes Bitcoin as Legal Tender

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El Salvador would be the first country in the world to adopt Bitcoin as legal tender.

Legal Tender

• It is defined as: coins or banknotes that must be accepted if offered in payment of a debt.
• A legal tender is guaranteed by the central government and all parties are legally bound to accept it as a mode of payment.
• Fiat money is a government-issued currency that is not backed by a commodity such as gold.
• Virtual currency is a digitally tradable form of value, which can be used as a medium of exchange, or a stored value which can be utilised later.  It does not have the status of a legal tender.  

Cryptocurrency

• It is a specific type of virtual currency, which is decentralised and protected by cryptographic encryption techniques – block chain technology, a system of distributed, cryptographically secured account keeping. 
• In this system, the users keep a tab on every digital ‘coin’ and transaction rather than a banking system with a governing body at its centre. 
  • Examples: Bitcoin, Etherium, Tether, Ripple and Binance Coin
• Bitcoin is a type of digital currency in which a record of transactions is maintained and new units of currency are generated by the computational solution of mathematical problems, and which operates independently of a central bank.
• Bitcoin is the first and biggest of decentralised cryptocurrencies, which are online payment systems. 

Countries on use of Cryptocurrencies

Benefits of Crypto-currency and DLT

• DLT, could improve the efficiency and inclusiveness of the financial system. 
• It can help lower the costs of personal identification for KYC, 
• Improve access to credit. 
• It could provide Faster transactions. For example, they can be used for small value cross-border transfers where the cost of sending remittances remains high due to multiple intermediaries.  
• Cryptocurrencies also provide for a more secure payment mechanism (as records cannot be manipulated by a single entity).
• More transparency in transactions.
• It will provide improved ease of auditing.

Applications of Distributed Ledger Technology (DLT)

Issues with Cryptocurrencies

• Threat to centralised control: Due to their core nature that shuns centralised control, governments globally have been wary of cryptocurrencies. 
• Highly volatile: Crypto currencies are highly volatile and have high fluctuation rates. The price of virtual currencies is a matter of mere speculation resulting in spurt and volatility in their prices.
• Reluctance from Governments: Most governments have warned their citizens against investing in cryptocurrencies, let alone allowing transactions in them.  
• Not secured: The increasing popularity will promote the use of Cryptocurrency or Bitcoin in particular, opening ways to fraudery and as an alternative to Fiat Currency.
• Increasing pollution due to its working mechanism: The ‘mining’ of Bitcoin, where individuals or companies set up powerful systems to support the blockchain network, for which they are rewarded in the currency, consumes huge amounts of energy and produces million metric tonnes of carbon dioxide emissions a year. 
• Compliance of FATF Guidance: With large scale cryptocurrency inflows and outflows, it would be expected from countries to comply with the 2019 Financial Action Task Force (FATF) guidance on Virtual Currencies.

Currency of El Salvador

• El Salvador fully ‘dollarized’ its economy in 2001 to-
  • take advantage of the stability that it offers and attract investments.
  • get linked to the monetary policies of the FederalReserve in Washington.
  • prevent hyperinflation in the economy

Reason given by El Salvador for using Bitcoin

• Addresses effects of Central Banks: They are increasingly taking actions that may cause harm to the economic stability of El Salvador so Bitcoin was being adopted in order to mitigate the negative impact from central banks.
• Saves Remittances: The country’s economy is heavily reliant on remittances from its citizens working abroad. According to World Bank data, remittances made up about 20% of the country’s GDP — one of the highest ratios in the world. By enabling the transfer of money via Bitcoins, citizens will save on transaction fees of banks and agencies. 
• Protection by Government: The government will protect citizens from the volatility of Bitcoin prices by guaranteeing quick convertibility to dollars. E.g. If a shopkeeper does not want to hold the Bitcoin which they now have to accept from customers, the government will purchase it through a $150million trust created at the country’s development bank. 
• Managing Carbon Footprint: As for the carbon footprint, the Stateowned geothermal electric company, LaGeo, to connect renewable energy from the country’s volcanoes to bitcoin mining facilities.

When El Salvador can do it, why can’t the rest of the world?

• The basis of the move is that El Salvador has no monetary policy of its own and hence, no local currency to protect. The country was officially ‘dollarized’ in 2001 and runs on the monetary policy of the US Federal Reserve.
• To avoid and mitigate the effects of the Central Bank’s policy and remain at par on the purchasing power front, it becomes necessary to authorize the circulation of a digital currency with a supply that cannot be controlled by any central bank.

Way Forward For India

• The overall takeaway for India from the El Salvador case is not in the monetary sense at all but as an example of how far countries are willing to go to attract innovators and entrepreneurs working on this emerging sector. 
• This is the wealth that India has in spades and has barely protected with policy. 
• While deliberations continue in India on the monetary and financial regulations around cryptocurrency, it is important that attention be paid to incentives for India’s developers working on key innovations in the space.

Sources: TH