El Salvador has become the first country in the world to declare Bitcoin as legal tender.
It means that if you buy something at a shop in this country or eat at a restaurant, you can make the payment using Bitcoins. And if the other person has the technology to accept Bitcoins, then legally, they cannot refuse to accept it.
The President of this country, Nayib Bukele, is quite young.
By
looking at the photo you can't really say that he's the President of a country.
He looks like the boy next door. He said that it is a historic step for his
country towards financial inclusion and economic growth.
What
does it mean?
By doing this, what will be the effect on the economy and finance of his country?
And what can the other countries learn from it?
Come let's try to find out in today's article
For those of you who don't know, El Salvador is a small country in Central America.
Once this country was considered the most dangerous country in the world. Because the murder rate here was the highest in the world. In the last few years, the situation has improved. But even now poverty, inequality, and gang crime are still seen a lot here. Talking about cryptocurrency, some other countries had also shown interest in declaring cryptocurrency as legal tender.
Like
in 2018 when Venezuela had shared its plan to create a cryptocurrency that will
be oil-backed. But Venezuela's idea flopped. El Salvador questioned the need
for a new cryptocurrency. The most popular cryptocurrency is Bitcoin. They
decided to declare it as legal tender. I believe all of us have heard the term
'legal tender' five years ago. In the "The notes of ₹500 and ₹1,000 will
not be legal tenders after tonight" speech. Now El Salvador did the exact
opposite. They've declared that from now onwards, Bitcoin will be legal tender.
Meaning that people can use Bitcoin in their day-to-day activities. The
difference between declaring something 'legal' and 'legal tender' is that many
countries have declared Bitcoin to be 'legal'. That you can buy and sell
Bitcoin.
Make payment to someone with Bitcoin. It is allowed in many countries. But declaring it as 'legal tender' means that if you make a payment in Bitcoin, the other party cannot reject the Bitcoin. They will have to accept it. It is clearly written in their new legislature "Every economic agent must accept Bitcoin as payment when offered to him by whoever acquires a good or service." According to this law, even the tax payments to the Government can be made in Bitcoins. And the Government has repealed the Capital Gains tax on the exchange of Bitcoin. Now all of these were just theoretical.
How will it work in reality?
There are now two legal tenders in El Salvador. One, their own currency. Actually, they stopped using their own currency in 2001 and have been using US Dollars exclusively. So now the US Dollar is a legal tender in their country. And two, Bitcoin is now legal tender in their country.
Does this mean that the goods in the shops of El Salvador will have the price written in two currencies on the price tags?
First in US Dollar and then in Bitcoin?
No, this does not mean this. Because Bitcoin is a highly volatile currency. If they start writing it on the price tags of products in a shop, like the price of tomatoes in Bitcoin, then every minute of every hour that price will need to be revised.
The second problem is that, as we all know, the price of Bitcoin is around $35,000 - $40,000. And around ₹25 lakhs in Indian Rupees. So the price of one tomato will be something like 0.0001 Bitcoin.
So will it make any sense of writing down all the zeros on the price tag?
They've come up with a simple solution for this as well. They've said that they will have the prices in US Dollars. And the conversion rate between US Dollar and Bitcoin at that time will be used to calculate the amount that needs to be paid in Bitcoin. According to the US Dollar price tag. So if the price of a tomato is 20¢, you will pay the 20¢ in Bitcoin.
There is an exception to this law. The people who do not have the technology to accept Bitcoins, don't need to accept Bitcoins. But at the same time, the government has also said that they will provide necessary training and mechanisms to the people so that people may carry out transactions in Bitcoin, and can learn transacting in Bitcoins.
But what will happen when you pay someone in Bitcoin and in the time that the transaction takes, the price of Bitcoin fluctuates rapidly. By the time the other person receives the payment in Bitcoin the price has changed significantly. To avoid this, the El Salvador government has created a trust of $150 million, that will guarantee the convertibility of Bitcoin to Dollars at the time of transaction.
Meaning that if you use Bitcoin to pay a shopkeeper, and the shopkeeper says that he doesn't want to keep the Bitcoin stored with him, that he wants to get it changed into US Dollars immediately, then he will have the option to do so. The government has decided to do this so that people are not forced into doing something they don't want to do. So that people are not forced into using Bitcoin, or storing it.
If some people think that because the price of Bitcoin fluctuates a lot, so they do not want to use it much. Then they can avoid the risks in this way. They will not have to base their business calculations and balance sheet on Bitcoins. By doing this, the adoption of Bitcoin by the people in the country will be organic.
Why did El Salvador choose Bitcoin only?
Perhaps because Bitcoin is the most popular cryptocurrency. But if some country wants to make some other cryptocurrency their legal tender then they will need to consider some factors.
Like the country in which the cryptocurrency is based, if a cryptocurrency is based in countries like China or Russia, that may not be very trustworthy. As compared to a cryptocurrency, take EtherLite for example, that is based in countries like Singapore and Germany, it will be more trustworthy.
I'll explain these points with the example of EtherLite. After this, there needs to be a background check to identify the stakeholders of the cryptocurrency. And a background check of these people backing the cryptocurrency. The energy consumption of the cryptocurrency. The lower it is, the better.
In the case of EtherLite, it is very low. How secure and stable the cryptocurrency is.
Has there been an audit into the cryptocurrency by well known and reputed agencies?
Like EtherLite has been audited by the agencies Techrate and Hacken. Which are considered to be very reputed. After this, its affordability.
How affordable is a cryptocurrency?
And finally comes the point of the transaction cost. If you have to use a cryptocurrency in day-to-day life, then the transaction cost needs to be low. This is true in the case of EtherLite. But it is not in the case of Bitcoin.
To avoid this problem, their government has decided to use Strike based Bitcoin Wallet App. Basically, this builds another blockchain over the existing Bitcoin Blockchain so the transaction time reduces and becomes faster And the fees charges is also minimal. It was very essential to incorporate. Without it, it was next to impossible to use Bitcoin in day-to-day life. In the law, it is also mentioned that the mobile carrier companies should have the Government wallet in all the devices that they sell.
But what are the challenges that El Salvador will have to face here?
And what are the points of criticism of this decision?
Let's talk about it. The first point. Several experts believe that the majority of the people in their country will not use Bitcoin in their day-to-day life.
Why?
Because if there is an expectation of a future increase in the price of Bitcoin, if people believe that the value of Bitcoin will increase in the future, then they wouldn't want to spend Bitcoin. They would want to store all the Bitcoin they have. So that they can get a higher return on it later.
On the other hand, if there is an expectation in the market that the price of Bitcoin will fall, then why will anyone want to accept Bitcoin?
As a form of payment. They will say that they do not want to keep it with them because its price will fall. People will simply prefer US Dollars. Because it is easier to use it while doing a transaction. There will be no issue with the price. So it may be quite difficult to overcome this challenge.
For this reason, some people believe that instead of choosing Bitcoin, El Salvador should've chosen some other cryptocurrency. Like any Stablecoin. Stablecoins are cryptocurrencies whose prices remain fixed. Like the Tether cryptocurrency. Its price is fixed at $1. It does not fluctuate.
The second point of criticism is the harmful environmental impact of Bitcoin mining. Because Bitcoin is based on an old blockchain, the system of blockchain designed at the time was so energy consuming and energy wasting that a lot of energy and electricity is used for mining Bitcoin. To the extent that currently the electricity consumed for mining Bitcoin globally is more than the electricity consumed by a country like Sweden.
This was the reason why the World Bank refused El Salvador's request. When El Salvador made this decision, they went to the World Bank and requested help in the implementation of this process. But the World Bank rejected the request saying that the environmental impact of Bitcoin mining is too severe. Because they were concerned about it, they refused to help with it.
This problem could have been easily avoided if El Salvador had chosen some other cryptocurrency instead of Bitcoin, because nearly all alternative cryptocurrencies use less energy as compared to Bitcoin. All of them are built on upgraded Blockchains, which have lower energy consumption.
The improvement in the coin similar to Bitcoin, the Litecoin it is 30 times more energy-saving than Bitcoin. Ethereum is another popular Blockchain that is used for many smart contracts and other avenues.
An improvement to it is coming, called EtherLite. EtherLite is said to be even more energy saving. It builds upon the existing Ethereum infrastructure. And the shortcomings in the security features of Ethereum, are also addressed. So that it can be even more safe, secure and sustainable blockchain.
By the way, this coin hasn't been released yet. It will be released on 1st July. Anyways, coming back to the criticisms.
Some people are even more pessimistic about El Salvador's decision. Like Professor Steve Hanke of the Johns Hopkins University. He says that because of this decision, what remains of El Salvador's economy might all crash. He says that the Bitcoin traders in countries like Russia and China can bring down the entire economy of El Salvador if they want to. They can drain all their holdings. And can steal from it. By controlling the value of Bitcoin. Especially when El Salvador converts its US Dollars into Bitcoins. Professor Hanke isn't against cryptocurrency.
In
fact, he believes that cryptocurrencies are the future of money. But at the
same time, he says that
"But, unfortunately, Bitcoin is not."
So now a question arises, despite so many concerns and challenges, Why did El Salvador make this decision?
Let's look at it from their perspective.
What does their President believe about the possible benefits of this decision?
First, their President believes that because of this decision, there will be an increase in Financial Inclusion in the country. And jobs will be generated. 70% of the population in El Salvador do not have a bank account. So they rely on the informal economy. Their President believes that by increasing the popularity of Bitcoin people will use cell phones. They will use the Bitcoin wallets on their cellphones.
Through this, they can become a part of the financial system. And this can only happen when people already have mobile phones. But that's not an issue. Mobile penetration in El Salvador is at 145%.
Second, he believes that their GDP will increase because of this decision. He says that once foreigners see that El Salvador is doing this they will want to invest in their country. He also says that the market capitalization of Bitcoin is at $680 billion, and if even 1% of it is invested in El Salvador, then their GDP will increase by 25%. And to encourage this investment, he has removed the Captial Gain tax on Bitcoin. And promised to give permanent residency to crypto-entrepreneurs.
There is a US-based cryptocurrency ATM manufacturer that has decided to move its operations and manufacturing to El Salvador. And will set up a huge manufacturing unit there. So that their country can become a manufacturing hub of cryptocurrency ATMs. For the Americas.
For
North America and South America. Relying on this logic he says that jobs will
be created in his country because of this decision. If we use this sense, then
this decision has already been successful to some extent. Google trends have
shown that
Google searches for El Salvador real estate have increased rapidly in the English language. Meaning that foreigners are trying to find real estate in El Salvador. There's a counter-argument here as well.
The people who have invested
in Bitcoin, the millionaires of Bitcoin, generally, they do not use Bitcoin to
invest in something else. Because to them, Bitcoin is an investment. So the
thing on which El Salvador has pinned its hopes on, that people will invest in
different sectors in their country, may not actually happen. The most that can
happen is that they buy some property or real estate in their country. Only
time will reveal the sort of investments that will be seen in El Salvador. Another
direct benefit of making cryptocurrency a legal tender in El Salvador is in
Money Remittance.
When
expatriates send money to their home country, it costs them a lot nowadays. Because
all the companies charge high fees. It is estimated that the fees charged is
somewhere between 5% - 9% to send money from one country to another. Here,
there is a huge advantage in using cryptocurrency because the fees for
international transfer is quite low.
And
many people in El Salvador use this for remittances.
In fact for a country like El Salvador, where the population of the entire country is only 6 million, and the migrants from El Salvador, for example in the US, there are about 2 million people from El Salvador. When so many citizens reside in another country, a lot of money is remitted to the country for their friends and family members. To the extent that the money coming into their country as remittances, is around 20% of the GDP of the entire country. Meaning that one-fifth of the country's GDP is from remittances. So it will definitely be very useful for this country.
People will save so much money by using cryptocurrency. Overall, only time will tell if this decision is successful or is a failure. But one thing is definite, friends, whether the governments make cryptocurrencies legal tenders or not, organic growth of cryptocurrencies has been seen in several countries to a large extent. There are many African countries where the banking infrastructure isn't good enough. Where the remittance fees are very high. People have started regularly using cryptocurrencies there on their own. In Africa, the country with the highest cryptocurrency usage is Nigeria. Where 31% of the country's population used cryptocurrency at least once.
After El Salvador, other South American countries are now showing their interest in making cryptocurrencies their legal tender. Will those countries choose Bitcoin to make into legal tender too? Or an upgraded and improved cryptocurrency like EtherLite or some other cryptocurrency that may come in the future, Will they choose them? Or will they try to create their own cryptocurrency? It will be interesting to see. I hope you found this article informative.
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