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El Salvador allowed cryptocurrency payments. What does it mean?

Photo: President of El Salvador Nayyib Armando Bukele speaking at a press conference. Source: Bloomberg

1. What did El Salvador do?

El Salvador’s 39-year-old President Nayib Bukele pushed Congress to approve a plan to make El Salvador the first country to use bitcoin as legal tender. According to the bill, Salvadorans can now pay taxes in bitcoins, and “business entities” will be required to accept cryptocurrency as payment for goods and services. The US dollar will continue to circulate alongside bitcoin as the national currency in this Central American state.

2. How will Bitcoin be used as legal tender?

Many unresolved issues remain. In theory, Bitcoin will create a parallel payment channel alongside the US dollar. Prices can be quoted in cryptocurrency and exchanges using it will be exempt from capital gains tax. The bill passed by Congress calls for the creation of a fund that guarantees the convertibility of bitcoin into dollars.

3. What prompted you to take this step?

Remittances account for roughly 20% of the country’s gross domestic product and mainly come from Salvadorans working in the United States. According to Bukele, people lose most of that money on transfers due to fees that bitcoin might help lower. El Salvador is a so-called dollarized economy, which means that the fiscal and monetary decisions of the US government and the Fed have a huge impact on the country. Thanks to the adoption of Bitcoin, she can gain more independence.

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4. How else can this help?

Bukele argues that El Salvador could become a hub for bitcoin mining, a process by which transactions are verified in exchange for new coins. Bukele wrote in one tweet that if El Salvador had at least 1% of the huge value of bitcoin, then the country’s gross domestic product would increase by 25%; although he could not describe a clear mechanism by which it would be possible to increase GDP.

5. Can El Salvador do it?

Bitcoin mining, which involves complex computation and enormous computing power, is increasingly being criticized due to the use of electricity and environmental pollution.

Bukele tweeted, “I just tasked the president of @LaGeoSV (our state-owned geothermal electric company) with developing a plan to provide #bitcoin mining opportunities with very cheap, 100% clean, 100% renewable energy from our volcanoes that delivers zero emissions. “.

Whether it succeeds or not, the move is undoubtedly in line with Bukele’s attempts to portray a new type of Latin American leader. He is known to tweet, surf and wear baseball caps backwards, among other things. In a photo on his Twitter profile, he even uses “laser eyes” popular among crypto enthusiasts.

6. What is the innovation of this experiment?

Bitcoin is used in some regions for some transactions. For example, it is already being used informally in some parts of El Salvador, for example, in the beach town of El Zonte, where more than 30 businesses already accept cryptocurrency for payment, and there are also two Bitcoin ATMs. But its volatility – price fluctuations – make it unattractive to many companies. It has lost almost half of its value since mid-April. Many companies are reluctant to accept payments in currencies today that will cost less tomorrow, even though it is likely to rise in value. Even in tech hubs such as Silicon Valley and Singapore, bitcoin is still only marginally used as a medium of exchange. On the other hand, in El Salvador, the government and central bank are actively encouraging its use, which may give impetus to its widespread adoption.

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7. What other risks can there be?

Cryptocurrencies are subject to hacker attacks, and users who incorrectly enter the code confirming their owner status may “lose” their bitcoins. Bitcoin’s widespread adoption could also make El Salvador a tax haven – or an oasis for money laundering. And if it does attract the bitcoin whales – large currency holders who decide to move coins to El Salvador, the recurrence of the boom and bust cycles bitcoin regularly experiences could be disastrous for an economy with a GDP of $ 27 billion.

8. What does this mean for the bitcoin community?

In recent years, Bitcoin has attracted more and more interest from traditional financial companies, which are looking at cryptocurrency as a potentially lucrative new area. But the main question remained unresolved: is bitcoin primarily a tool for financial transactions, like the dollar and other traditional currencies? Or is it worth buying as a store of value that, like gold, is less linked to economic cycles than many other assets? It is worth closely monitoring what is happening in this country of six million people to find a clue to the answer to this question.

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9. Do other countries do it?

Actually, no. Many central banks develop their own digital currencies, but they are very different from cryptocurrencies like Bitcoin, whose owners value independence from governments. For example, the Sand Dollar Bahamian currency is simply an offshoot of the Bahamian dollar and trades with it on a one-to-one basis.

10. What could have prompted El Salvador to make this decision?

Last year, the country’s economy suffered its worst collapse in forty years, while the budget deficit exceeded 10% of GDP, as tight restrictions designed to limit the spread of Covid-19 caused serious damage to business. This forced the government to look for new sources of funding. The Treasury Department is in talks with the International Monetary Fund for a $ 1.3 billion loan to finance this year’s spending, but negotiations have stalled. A dangerous situation remains in the country. Bukele says his government has a security policy to tackle homicide, but the murder rate is still four times higher than in the US, and relations between Bukele and the US government have been complicated by mistreatment of prisoners and his dismissal by a party of judges. the Constitutional Court and the Prosecutor General for Combating Corruption.

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