Will Other Countries Follow El Salvador Into Making Bitcoin A Legal Tender?

San Salvador in El Salvador
Credit: David Duran -

On Tuesday, the Salvadoran Congress passed the historic bill that adopts Bitcoin (BTC) as the legal tender for El Salvador, marking the new peak of the cryptocurrency revolution. Nayib Bukele, the 39-year-old President, has turned to Bitcoin as the nation’s hope to reform the economy.

The appeal of cryptocurrency as a legal tender is becoming attractive to developing countries mostly because third-world governments lack sophisticated financial systems to manage currencies and make payments seamless. So what do they do? In the past, the solution was simple for some governments. Countries like El Salvador and Venezuela simply adopted the U.S. dollar as the legal tender. The thesis behind the move was sound. Citizens view the U.S. dollar as the “gold standard” with a stable value. So, the solution of using U.S. dollars was satisfactory for El Salvador.

However, the pandemic has dwindled the appeal of U.S. dollars because the Federal Reserve is ramping up the supply of circulating U.S. dollars. To be exact, the M2 money stock expanded from $15.35 trillion in February 2020 to $20.11 trillion in April 2021. That’s a nearly unprecedented increase of 32 percent in only 14 months.

FRED M2 money stock

The Fed arguably made the right move because it succeeded in pumping cash into U.S. financial institutions and other areas of the U.S. economy to help the country recover from the lockdown. But Salvadorans didn’t enjoy any benefit from the surge in the new U.S. dollars. Instead, they saw their purchasing power go down due to the U.S. monetary inflation.

Now, is it fair for citizens of El Salvador and other developing countries to watch their money’s value decline because of the self-interest moves made by a foreign government?

This is the main thesis behind President Nayib Bukele’s decision to make Bitcoin the legal tender of El Salvador. In the proposed legislation, it said that the Fed’s actions that hurt El Salvador’s economy:

“Central banks are increasingly taking actions that may cause harm to the economic stability of El Salvador…in order to mitigate the negative impact of central banks, it becomes necessary to authorize the circulation of a digital currency with a supply that cannot be controlled by any central bank and is only altered in accord with objective and calculable criteria.”

Remittances Make Up 20% Of El Salvador’s GDP

Sending money is a breeze for Americans. If you want to send money to your friend, all you need to do is open a payment app (like Cash or Venmo) and send money in seconds. But that’s not the case for developing countries like El Salvador. According to President Nayib Burke, as many as 70 percent of Salvadorans don’t have a bank account so they rely on shady operations that exploit the broken financial system.

Here’s an example. More than two million Salvadorans live outside the country, and they sent back $5.92 billion to their friends and families in 2020. Believe it or not, remittances (money sent home from aboard), make up around 20% of the country’s gross domestic product, according to World Bank Group.

Now, the remittances often must go through middlemen but they take cuts as large as 20 percent. Rather than low-income families receiving much-needed cash, middlemen are taking advantage of the system to make lucrative profits for themselves. With Bitcoin, the middlemen are cut out and families can exchange money directly, even if they don’t own a bank account. All they need is a mobile phone to open a cryptocurrency wallet. This solution alone can save low-income families billions of dollars every year.

Nayib Bukele tweet

Here’s Why Making Bitcoin A Legal Tender Is Important

The U.S. tax treatment of Bitcoin makes it difficult to use cryptocurrency for everyday payments. Back in 2014, the Internal Revenue Service defined cryptocurrencies as “property for Federal income tax purposes.” This means if you purchased one Bitcoin five years ago when its price was lower, and you finally decided to spend it to buy lunch, you’ve triggered a taxable event for which you have to report capital gains.

However, the IRS doesn’t require you to pay capital gain tax if you convert foreign currencies like euros into the U.S. dollar. Now, if Bitcoin is legal tender in the same way that foreign currencies are, it becomes far easier to use Bitcoin for ordinary payments because it is now treated as a currency -- rather than an asset. This is the key part of El Salvador’s recently passed bill:

Avik Roy tweet

Final Notes On The Bitcoin Bill

El Salvador’s Secretary of Commerce Miguel Kattán said that while Bitcoin would be part of the local economy, no one is required to use Bitcoin and the U.S. dollar will remain as a legal tender.

Plus, all goods will stay dollar-denominated in El Salvador. For example, coffee that costs 5 cents will still cost 5 cents, even if Bitcoin is available as a payment in the coffee shop. Plus, the accounting purposes will reflect in U.S. dollars.

While El Salvador will not yet fully adopt Bitcoin as the primary currency in its local economy, its move reaches the new summit in the momentum of cryptocurrency. As recent as five years ago, the idea of a country making Bitcoin a legal tender would be a nonstarter. This may be the domino effect that leads other countries to adopt Bitcoin as a legal tender, as well.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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