Here’s why El Salvador made Bitcoin legal

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The rare event occurred in June 2021, marking what could be a turning point in the crypto world. Until this announcement, governments have been combative when it comes to cryptos. Their consideration for this digital asset ranges from their acceptance as investment assets but not as currency to a total ban on their use.

What this acceptance implies on the ground is that Salvadorans can use bitcoin as a medium of exchange. Much the same way they use the US dollar and previously the Salvadoran settler. You can now buy products at any point of sale in the country.

Causes of Bitcoin adoption by El Salvador

It would be wise to know more about the reasons for such a move. Why is El Salvador finally deciding that Bitcoin should be legal tender?

Make money transfers less expensive

First, its economy depends on diaspora remittances. These revenues represent nearly 25% of the country’s GDP, and they are an integral part of the levels of its economic dynamism.

Given such a position, the costs associated with sending funds to the country are very significant. The government of Nayib Bukele, the president of the country, affirmed this situation via a tweet. Making Bitcoin legal tender makes the process of receiving funds from abroad more accessible to recipients. There are cost advantages, helping users avoid the high transfer fees charged by third parties.

Increase financial inclusion rates

El Salvador faces the same problems as most developing countries, namely low bank account penetration rates. The main cause is insufficient infrastructure for financial service providers such as bank branches.

To counter this problem, the president believes that adopting cryptos is a better solution. For starters, Bitcoin is a digital currency that does not involve any physical form. It therefore does not require the presence of physical branches to allow accessibility. Physical branches have huge construction costs and branch support infrastructure like roads and electricity.

The story continues

Increase the levels of economic growth of nations

A key consideration for the adoption of Bitcoin as legal tender by El Salvador is dealing with its low annual GDP growth rates. According to World Bank data, the country has not broken the barrier of 4% GDP growth rate over the past decade.

Among the issues that led to this were the monetary issues, which led to the adoption of the US dollar as legal tender. However, the government chose to use bitcoin. The asset leaves El Salvador at much lower exposure to external manipulation. The use of the US dollar leaves the country at the mercy of the monetary policy instruments of the US federal government.

Potential drawbacks

While very effective as a tool for cutting costs and increasing financial inclusion, it has drawbacks like anything else. The shortcomings range from the implementation phase to the economic implications. They understand

Increased exposure to volatility

The volatile nature of cryptocurrencies is a puzzle. Only stablecoins get more stable trade value. This is not particularly a problem for investors since they seem to only see the returns from price gains. This is what made cryptos one of the best performing assets during the economic recession induced by Covid 19.

But that becomes a problem when use as a business unit is concerned. The estimation of commodity prices will be a major concern given the huge fluctuations in their estimate of value. A plot of land worth 1BTC today may be worth 1.3BTC or 0.7BTC tomorrow.

Such price fluctuations greatly increase the possibility of overshooting as well as the susceptibility to hyperinflation. Once prices start to soar, it will be difficult to break the momentum even if the government has monetary policies. Cases like Zimbabwe’s hyperinflation are good examples.

Reduced government control over monetary policies

Another unforeseen problem with the adoption of Crypto as legal tender is the loss of effectiveness of government policies.

Governments hold enormous power to influence the direction and vitality of economies through monetary policies. The increase or decrease in the money supply in the economy can affect inflation rates, change interest rates on loans, or even influence exchange rates. However, it has emerged that they repeatedly abuse these powers for the benefit of a few.

Cryptos like Bitcoin, on the other hand, pose a key problem. Outside of stablecoins, crypto prices rely on the forces of supply and demand. Such a pricing system is very effective for investment gains while also eliminating currency manipulation rates. But that means the Salvadoran government will have no way of controlling inflation. Nor will it be able to stimulate the economy during a recession or influence lending rates.

Closing remarks

Adopting crypto as legal tender is quite beneficial for several parties. The government will increase financial inclusion while reducing exposure to foreign government policies while stimulating growth. Salvadorians will be able to take advantage of cheaper financial transfer rates. These are the main reasons the government has switched to bitcoin.

A big beneficiary is the crypto community, more specifically its credibility. But issues such as susceptibility to price volatility and inflation need to be addressed.

This article originally appeared on FX Empire

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