What does it mean to use Bitcoin as a legal tender?

Unless citizens can demonstrate that they do not have access to the necessary technology, they can use Bitcoin as a form of payment if BTC is treated as a legal tender in their respective jurisdiction.

Central banks and regulators of a nation generally decide what is legal tender within their economy. This means that whatever form of value they deem fit to be a legal tender can be used to pay for goods at shops. For instance, $10 notes and $.50 coins are legal tender in the United States.

Making Bitcoin (BTC) legal tender means that when someone wants to pay for a cup of coffee, they can use BTC to pay for it. Without a central bank declaring Bitcoin as legal tender, the risk of accepting BTC for goods sold would be with the shopkeepers. If the central bank has explicitly declared Bitcoin as a legal tender, then it becomes an official form of value exchange within the economy.

The rise of Bitcoin and a few other decentralized cryptocurrencies has also catalyzed several central banks to consider digital currencies as a more robust alternative to fiat currencies. As a result, many countries including China, the United Kingdom, the U.S., and India are all working on their central bank digital currencies (CBDC).

In these countries, the rationale for embracing digital currencies is to achieve better traceability and control of every unit of money in the economy. This traceability will help them with calculating taxes more accurately and identifying money launderers, but more importantly, spotting any accumulation of wealth and coming up with policies to keep it within their economies.

What factors generally catalyze a country’s adoption of Bitcoin as a legal tender?

Typically there are macroeconomic factors that a country is looking to manage through the adoption of a currency as legal tender. To make Bitcoin legal tender, these factors should coincide with visionary leadership.

Despite that, central banks are getting into digital currencies. There are countries with more fundamental problems that just a digital version of a fiat currency may not solve. For instance, countries like Argentina and Venezuela have suffered from hyperinflation for years and can do with a form of currency that derives value from much beyond their economies. There are also countries like El Salvador, Panama, Guatemala, and Honduras, where a big percentage of the GDP is contributed by remittances. This paves the way for a form of value exchange that is not restricted by national borders. For instance, 24.07% of El Salvador’s GDP in 2020 came from remittances.

One more consideration for countries is the extent of financial inclusion in their economies. While the customer journey around cryptocurrencies is by no means user-friendly, it must be said that hyperlocal experiments in creating an ecosystem on bitcoin in countries like El Salvador have seen some success. With remittances contributing to the economy in a big way, digital currencies can not only help financial inclusion but also achieve cost savings on remittance fees.

It should also be noted that regimes that roll out Bitcoin as legal tender have claimed to be bringing financial inclusion to their population. Yet, financial inclusion often must be preceded by mobile and internet penetration. Without the digital infrastructure, a digital currency will not be able to solve the problem of financial inclusion all by itself.

So, which countries have adopted Bitcoin as a legal tender, and how have they done it? El Salvador is the first country to adopt Bitcoin as a legal tender. Apart from the macroeconomic factors described above, the country had a leader who was willing to experiment with bitcoin. He has since been a loyal ambassador of cryptocurrency.

The second country to adopt Bitcoin as legal tender is the Central African Republic (CAR). The CAR is rich in natural resources like gold and diamond and has a $2.3 billion sized economy. Yet, financial inclusion is pretty low and they rely on remittances. Apart from embracing Bitcoin, the country also revealed that 20% of their treasury will hold Sango Coin (SANGO), a digital currency that will reflect the health of natural resources in the country.

What do the countries intend to achieve by accepting BTC as a legal tender?

Countries rely on effective monetary policy as a key lever to manage their economies. Therefore, they need a credible currency and the ability to maneuver the policies around the currency in times of crisis.

Both El Salvador and CAR have identified that they want to make money transfers into the country cheaper. El Salvador’s president Nayib Bukele projected a $400 million saving with remittances as the country moves to Bitcoin infrastructure. Using the Bitcoin lightning network, payments could be cheaper than existing methods.

On a macroeconomic basis, the currencies of these countries have generally struggled to hold value against the U.S. dollar. El Salvador switched to using the USD as its currency but soon realized that most of its exports were to the U.S. and a weakening dollar did more harm than good to their people. Unlike other Latin American economies, El Salvador didn’t have very high inflation before it embraced the dollar.

To add to that, they did not have any control over the monetary policy around the USD, which is controlled by a centralized entity in another country. Therefore, the country was looking up to BTC to solve its key issues around remittances while not being affected by the fluctuations of the U.S. dollar.

What are the challenges of adopting Bitcoin as a legal tender?

There are liquidity and regulatory risks around the crypto market that a country will assume when they use it as legal tender. As the crypto market is highly correlated with the U.S. equity markets, the Federal Reserve’s policy changes will have an impact on the crypto prices.

The narrative that most of these countries have for adopting bitcoin is the lower cost of remittances to a highly unbanked population. This might be a shallow reason as most of these countries have very low digital and mobile penetration. Therefore, unless they can set up Bitcoin ATMs all over the country, it wouldn’t be practical for them to scale BTC as a default currency.

The other challenge is the volatile nature of the crypto market. As BTC fell by over 70% from its all-time high in November 2021, El Salvador made several buys of the cryptocurrency. Yet, the fall in Bitcoin prices has been relentless and most of these positions are currently held at a loss. For a country’s treasury to have used up citizens’ money in a volatile asset that can lose 70-80% of its value in six months, it cannot be known for its sound economic policy. Due to weak cash positions, the country’s ability to borrow more from international markets is also badly affected.

On another note, Bitcoin regulations are largely driven by national regulators. Due to the decentralized nature of the cryptocurrency, banning BTC in one national jurisdiction does not directly affect its legal status in another jurisdiction. Yet, when a country like the U.S. comes hard on cryptocurrencies through regulations, the market reacts to it. The price action that results can affect all countries that use Bitcoin as legal tender or as a reserve currency.

Which countries are banning Bitcoin and other cryptocurrencies?

Banning a global technology and economic paradigm like BTC is not the best approach for governments to protect their citizens from the risks of this asset class. It is by hand holding them through the journey, educating them, and setting the right controls in place that safeguarding retail customers can be achieved.

There have been several bans on BTC, other cryptocurrencies, and cryptocurrency mining across the world. China banned cryptocurrencies in 2021 in light of its central bank’s digital currency, and it also affected Bitcoin mining. As a result, the BTC hash rate fell in 2021. But, the industry was brought back to its feet by a rise in Bitcoin miners in the United States.

In 2022, India took a harsh stance on cryptocurrencies. If history is something to go by, every time there is a ban on this asset class in one part of the world, another region taps into the opportunity. Therefore, until there is a coordinated ban on cryptocurrencies across the world, it is extremely hard to curb the growth of BTC and digital assets in general.

Countries looking to ban cryptocurrencies to protect their citizens who are retail investors are likely not going to succeed. A more collaborative and democratic approach will help them achieve their objective of protecting retail investors.