In this FinMail we understand what led El Salvador to become the first country in the world to make Bitcoin it's official currency.
On the 9th of June 2021, El Salvador, a small country in Central America became the first country in the world to adopt Bitcoin as a legal tender. This means that Bitcoin would be adopted as a mode of transaction i.e. as a currency in El Salvador. The president of El Salvador, Nayib Bukele a week before had promised to send a bill to the government for approval of Bitcoin as a legal tender in the country. The president announced the news on Twitter saying that this will help El Salvador in growing its economy by providing access to credit, savings, investment, and secure transactions.
So in this issue of FinMail, we bring you the complete explanation of how El Salvador went on to accept Bitcoin, what were the problems faced by the current legal tender in El Salvador, what are the challenges El Salvador could face and also how it could affect other countries' decision regarding cryptocurrencies. Let us begin!
What is legal tender?
Legal tender is anything that is accepted by the law as a means to settle payments, debts, obligations, taxes, etc. For instance, "INR" is a legal tender in India. It means that any financial transaction can be settled with INR in India. Likewise, USD is a legal tender in US and in some other countries but not in India so here transactions can't happen using USD. This means that a country's law will define what the legal tender will be. Remember the time when ₹1000/- note was banned as a legal tender. Yes! now you got it.
Current Legal Tender in El Salvador:
Now that Bitcoin is accepted as a legal tender in El Salvador, it will co-exist as a legal tender along with the current legal tenders which are USD and their own currency Colón. Although Colón is still a legal tender in El Salvador, the majority of the people have shifted towards USD. Note here that Colón was the only legal tender in El Salvador until January 1, 2001, when USD was adapted as a legal tender through a Bill. After the bill was passed, the dependence of El Salvador on USD deepened.
But what made El Salvador accept USD as a legal tender?
El Salvador is the smallest country in Central America with a population of just 65 lakhs. For reference, the population of Ahmedabad is around 80 lakhs. Out of the total population of El Salvador, about 25% of them live in USA. Thus, the population residing outside sends hefty amounts of money to their families residing in El Salvador (remittance). The president said that last year in 2020, the citizens abroad sent home nearly $6 Billion in remittances despite the pandemic. This amount contributed to more than 20% of the GDP of El Salvador. So a large amount of USD was flowing in El Salvador before 2001 when the USD was not a legal tender, which meant that when the money was sent to people residing in El Salvador, they had to convert all those USD to their own currency Colón. So, there was an increased demand of Colón as the money is received in USD and it can't be used for spending anywhere which created an artificial scarcity of Colón, thus pushing up the valuation and making it more expensive. As Colón was overvalued, it created a lot of different problems for the economy.
For example, the exports would face challenges as the local products of El Salvador became costlier as compared to products of other countries. And also if a country's currency is overvalued, it will result in increased interest rates in the country. And no country wants its economy to suffer like this. Or do they?
So what could be a possible solution?
Let's eradicate the need to convert USD into local currency, let's start accepting USD. Smart!
But why Bitcoin now?
As mentioned remittances are a major contributor to El Salvador's GDP, more than 20% and last year nearly $6 Billion was sent by residents abroad. For sending the money and facilitate the transfers, people are paying hefty charges to the intermediaries and that was a major concern for the president which the president said could be eliminated by accepting Bitcoin. It would also help the country in reducing the dependency on USD.
Currently, 70% of the population does not have bank accounts in El Salvador. As Cryptocurrencies does not require bank accounts, the citizens would easily be able to adapt to Bitcoin as a result. The President mentioned all of this and also mentioned that, "Bitcoin has a market cap of $680 Billion. If 1% of it is invested in El Salvador, that would increase our GDP by 25%. On the other side, Bitcoin will have 10 Million potential new users and the fastest growing way to transfer 6 Billion Dollars a year in remittances."
So basically these are the argued reasons behind the introduction of Bitcoin as legal tender. But introducing Bitcoin or any new currency is not relatively new for the country. They have introduced USD 20 years back and have been using it since then. Also, in 2019 a small island in El Salvador introduced a project called "The Bitcoin Beach" Project in which they started a sustainable Bitcoin ecosystem where they introduced Bitcoin for regular usage from the ground levels, for the people who had no bank accounts. The Project helped the local residents in educating them about transacting with Bitcoin for various transactions like grocery, restaurant, barber shops etc. They also introduced a rewarding system for students who maintained good attendance in educational and sports activities. This local initiative soon went national and then international whereby everyone were surprised to know about it. Even the government came into the contact of its major promoter Jack Maller (CEO, Strike) and this led to the initiative being nationwide from just a local project.
All this is cool and fine, even the president who is a millennial has been enjoying this. Photos of the president with laser eyes (a popular trend in Bitcoin users) has been revolving all over Twitter but, there's a major concern. How would the decision pan out?
Introducing Bitcoin will bring out new challenges. IMF in particular is concerned about the decision, IMF has said that it will closely track the developments that happen and will constantly stay in touch with the authorities on the same. This is because recently the government of El Salvador is negotiating an agreement of $1.3 Billion with the IMF. Experts are of the opinion that the move can affect the negotiation with the IMF.
While this turned out to be great news for crypto, specifically BTC enthusiasts. Is this decision really a game-changer for El Salvador? Let's discuss the advantage & possible repercussions of this decision.
With the adaptation of Bitcoin, the majority of the population which do not have access to banking services will be included in the Financial System.
The President while announcing the news of Bitcoin also announced that there will be no capital gains tax on Bitcoin as it is a legal tender now. Also, he has invited crypto entrepreneurs in the nation and announced that they will be given permanent residency instantly. This would encourage outsiders to become a citizen of El Salvador and would help boost its economy.
When a currency is so volatile and is sensitive to the tweets of popular personalities, particularly one (you know who we are talking about), leaving a country's financial system to this could do more harm than good.
The President of El Salvador has had one particular dream since he came into office which was to reduce Gangwars and other Illegal Activities in the country. Since Bitcoin doesn't allow to identify the identity of the transactor, you can't trace a transaction back to a person or an entity which is an encouragement to those who want to fund/conduct illegal activities. Bitcoin would probably help them.
No control over the currency:
Every country regulates its currency in order to keep inflation and other macroeconomic factors in check. But accepting Bitcoin will no longer give power to the central bank or government to regulate it. Being volatile, this could be the pain to steer the economy from tough roads.
Can we expect other countries to do the same?
The eternal question - Will other countries follow and start accepting Cryptocurrencies at least. The world will be definitely watching how this decision of El Salvador pans out. If it pans out well, the countries that currently use other currencies than their own currency would definitely consider Cryptocurrencies as a legal tender as it would reduce their costs and also help boost their economy by being inclusive to crypto enthusiasts. When it comes to countries that are developing or developed who use their own currency would definitely watch this event on the sidelines but for them to accept them, we have a long way to go for sure.
So that is it for this week's FinMail. Keep learning & stay safe.
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