Using Bitcoin as legal tender? Will El Salvador's experiment succeed?

The El Salvador model cannot be simply copied.

While attending the Bitcoin 2021 conference held in Miami a few days ago, Salvadoran President Nayib Bukele announced that he would submit a draft Bitcoin legislation to the legislature in the near future to help Bitcoin become legal tender in El Salvador.

On June 9, a historic moment arrived.

That morning, Bukele formally submitted the draft bill to the El Salvador legislature. As his party holds 64 of the 84 seats in the country's legislature, the bill was eventually passed with an absolute majority of 62/84 votes in favor.

The bill will take effect within 90 days of being published, which means that El Salvador will become the first country in the world to use Bitcoin as legal tender.

Prior to this, most countries viewed Bitcoin as an asset rather than a currency. El Salvador’s move will allow Bitcoin to assume the function of currency in real transactions as a compliant asset for the first time. This is not only an experiment in the country’s monetary and financial innovation, but also a significant chapter in the history of Bitcoin development.

Today, the eyes of the world are on El Salvador, a small country in Central America.

Not mandatory to hold, exchangeable with US dollars

In an impromptu interview, Bukele revealed that citizens of El Salvador will have access to an official government wallet (designed by Strike) but that it will also allow recipients to automatically convert incoming bitcoins into dollars instantly if they do not want to take on the risk of holding an unstable asset like bitcoin.

At the same time, in order to offset the volatility of Bitcoin prices and ensure a stable exchange relationship between Bitcoin and the US dollar, the Salvadoran government is establishing a $150 million trust fund with the El Salvador Development Bank (BANDESAL): Bitcoin received by businesses and individuals at market prices will be exchanged back to US dollars for those who do not want to hold Bitcoin. Anyone who uses the official wallet to convert Bitcoin into US dollars is essentially selling Bitcoin to the trust fund. In this way, Bitcoin adoption will grow organically in the country, and those who think Bitcoin's volatility is too dangerous can also choose not to hold Bitcoin. "The purpose of the trust fund is not to make money, but to support the decision to make Bitcoin a legal tender," Bukele said in a conference call on Twitter.

Users will not be forced to use a government wallet either. They can also choose to use a private custodial or non-custodial Lightning wallet if they wish. Any private wallet service, whether provided by Strike or any other bank, can provide the same Bitcoin-to-USD conversion service described above.

Under this model, although Bitcoin has legal tender status in El Salvador, users and merchants are not allowed to refuse to accept Bitcoin payments in daily transactions. However, if users have doubts about the value of Bitcoin or do not want to hold Bitcoin for any other reason, they can convert the received Bitcoin into equivalent U.S. dollars through a trust fund at the same time as receiving Bitcoin payments. Merchants do not need to be forced to hold Bitcoin to provide Bitcoin change services to other users.

At the same time, considering that El Salvador is mainly an agricultural economy, domestic economic transactions mainly use cash, digital payment methods are not popular, and about 70% of the people do not have bank accounts or credit cards. It is conceivable how difficult it is to promote Bitcoin payments, which are naturally digital, in such a society. Coupled with the current sharp fluctuations in Bitcoin prices, in the foreseeable future, even if Bitcoin becomes legal tender, it may only be the choice of a few people in the country. Although more ordinary users may also see goods and services priced in Bitcoin in the free market, they will not choose Bitcoin as a payment currency.

But as a legal tender, Bitcoin is unlimited legal tender in El Salvador, and users must accept Bitcoin payment channels as one of their payment options, at least during transactions. However, El Salvador currently implements a less powerful enforcement method. Various private wallets can compete with the government's implementation, and no one is forced to hold Bitcoin.

The El Salvador model cannot be simply copied

After El Salvador recognized Bitcoin as legal tender, many questions surrounding this event began to be debated, such as how other countries around the world should treat Bitcoin in the future.

El Salvador’s Bitcoin Law allows prices to be expressed in Bitcoin and taxes to be paid in it, while transactions made in Bitcoin will not be subject to capital gains tax.

According to Richard Howlett, an attorney at Selachii Law Ltd. in London, if El Salvador declared their legal tender to be Bitcoin only, it would set up an argument that Bitcoin is not subject to capital gains tax elsewhere either.

“However, I fear that governments around the world, not wanting to lose capital gains tax revenue, will likely declare that they do not recognise it as a currency, it is still classed as an asset,” Howlett said, adding that this would require some form of legal precedent for it to change.

The fact that Bitcoin is legal tender in El Salvador means that legal provisions in the statute that refer to legal tender in other jurisdictions may now also cover Bitcoin. There are a lot of rules that apply to currencies, and Bitcoin was not included in them before. Now that Bitcoin has been adopted as legal tender by a particular country, it will have to reassess whether those rules are now applicable.

As far as international transactions are concerned, most large international companies would not be keen on using Bitcoin as a basis for transactions.

Governments and central banks around the world will be watching El Salvador's experiment to see if Bitcoin will become part of everyday life for payments, remittances and reserve assets for banks and businesses in the country. However, according to Howlett, the El Salvador model cannot be simply copied because each country will legislate in its own way according to its formal procedures, but "as the El Salvador model proves to be successful, other countries will follow suit."

He estimates that the most likely ones are those with “third world demographics” where Bitcoin adoption could generate unimaginable wealth for them. Howlett believes that by adopting Bitcoin as legal tender, a decentralized currency, it could help a country in the event of hyperinflation.

Geothermal energy mining may attract miners from all over the world

Cryptocurrency mining involves using a huge computing system to solve millions of complex calculations per second to verify transactions on the Bitcoin network. This requires a lot of energy for the maintenance, cooling and operation of the machines. However, the use of coal and fossil fuels to generate electricity for mining will cause serious environmental pollution, and therefore many people protest against mining and boycott Bitcoin.

Source: Twitter

Now, if El Salvador continues to use Bitcoin as legal tender, it may need to mine Bitcoin in a way that does not pollute the environment in order to form a sustainable production model. Renewable energy may be a good solution to this problem.

A geothermal pit dug next to a volcano will help power bitcoin mining operations in El Salvador, the country’s president said in a tweet on June 9.

President Nayib Bukele said: "I have just instructed the President of @LaGeoSV (our state-owned geothermal power company) to come up with a plan for a facility to provide very cheap, 100% clean, 100% renewable, 0-emission energy from volcanoes for Bitcoin mining." He added in a follow-up tweet: "Our engineers just told me that they have dug a new well that will provide approximately 95MW of 100% clean, 0-emission geothermal energy from our volcano. Start designing a complete Bitcoin mining center around this new well." He also attached a video of water vapor gushing out of the well in the tweet.