/Why Did El Salvador Adopt Bitcoin as Legal Tender

Why Did El Salvador Adopt Bitcoin as Legal Tender

The President of El Salvador, Nayib Bukele (here at a press conference in May 2020) led efforts to make Bitcoin legal in his country. Yuri Cortez / AFP via Getty Images Hide caption While „monetary policy would lose teeth”, which could pose a significant risk to countries` economic stability. If the value of legal tender is based on speculation, economic activity could detach from the real economy, with the associated risk to domestic prices. Money laundering is also easier. In September 2021, El Salvador became the first country to make Bitcoin legal, forcing all businesses to accept cryptocurrency. In an attempt to popularize and regulate its use, the government has given citizens financial incentives to download a special cryptocurrency app. At present, El Salvador is the only country that has recognized Bitcoin as legal tender. Most countries have passive laws that regulate Bitcoin. In these countries, Bitcoin is not regulated: it is not banned and it is not legalized as legal tender. Although it is generally considered an asset and therefore considered property for tax purposes. However, critics say that making bitcoin — notoriously volatile and not subject to central bank control — legal is an unjustifiable gamble for El Salvador`s already struggling economy.

The $200 million in taxpayer dollars allocated by Congress to the project is equivalent to 2.7 percent of the administration`s total budget for 2021, nearly three times the Agriculture Department`s budget for the year. The uncertainty introduced by bitcoin policy has caused the price of government bonds to plummet and halted negotiations on a deal with the International Monetary Fund (IMF) to plug a hole of more than $1 billion in its public finances. According to surveys, seven out of 10 Salvadorans do not want Bitcoin as legal tender. „I will continue to suffer with or without bitcoin,” said candy seller Jose Herrera, who said he had trouble accessing a cell phone. Hanke helped advise the Salvadoran government on the country`s dollarization when it introduced the U.S. dollar as the single currency in 2001. Since 1993, the Salvadoran colón has been pegged to the US dollar at a fixed exchange rate in order to control runaway inflation. After eight years, the government decided to completely replace the colón with the dollar. This has made the economy more stable and reduced borrowing costs, but has limited Salvadoran governments` freedom to spend, especially in times of financial crisis. Hanke and others have speculated that the Bitcoin movement is a first step toward the complete abolition of dollarization and the issuance of a national digital currency. This would both ease public spending and reduce the impact of US sanctions.

The introduction of a „foreign currency” has always been seen as a sign of monetary weakness. Countries that adopted the U.S. dollar, for example, or pegged their currency to its value, and in countries that did not adopt the euro because they considered it dangerous for their economies. There will be obstacles because Bitcoin is not easy to use. While many in El Salvador posted their successful Bitcoin purchases on social media, others marched through the streets in protest. El Salvador is the first country in the world to make Bitcoin cryptocurrency legal. President Nayib Bukele says the legalization of Bitcoin will help many Salvadorans, about 70 percent of whom do not have a bank account, make the transition to the formal economy. In particular, he expects this measure to make it cheaper and faster for citizens to receive remittances from abroad. Remittances were an important source of income for his heavily indebted country.

Some observers see a strange irony in the Salvadoran government`s decision to launch a digital currency that was largely designed to circumvent traditional controls that governments exert on money. Others fear that El Salvador could be used as a test object to advance the cryptocurrency promoters` agenda. Half of the country`s households downloaded the app when the Bitcoin law went into effect. However, since the beginning of 2022, very few households have joined the Early Movers. Among the first downloaders, more than 60% have not made a transaction after spending the free bitcoins provided with the account, and 20% have not yet spent the bonus. However, a small group of consumers, most of whom are bankable, educated, young and male, are very active in the app. This group was not the intended target of Bitcoin`s deployment. The same IMF document states that „the most direct costs of widespread adoption of a cryptoasset such as Bitcoin relate to macroeconomic stability” and that „government revenues would be exposed to currency risk if taxes were disclosed in advance in a cryptoasset.” .