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21 June

IMF Calling Out El Salvador, Will the First "Crab-Eater" Taste Any Sweetness?

On June 9th, El Salvador officially passed the Bitcoin as legal tender bill, which stipulates that goods can be priced in Bitcoin, Bitcoin can be used to pay taxes, and Bitcoin transactions will not face capital gains taxes. This is the first time that Bitcoin has become a legal tender at the national level since the birth of Bitcoin, thus creating history and, to a certain extent, it may affect the way people around the world use digital currencies.

As El Salvador is a low-income country with the most densely populated population in Central America and 70% of the population is unbanked, the new Bitcoin standard will be supported by the Lightning Network, so that Salvadoran citizens living around the world do not have to pay high remittance fees, and the received Bitcoin can be either convert back to U.S. dollars or be kept in their account as Bitcoin. On the other hand, El Salvador has abundant clean and carbon-free geothermal energy. Nearly a quarter of its electricity comes from volcanic heat. Geothermal energy that has not yet been developed is estimated to power 4% of the global Bitcoin network.

Soon after the bill was passed, the spokesperson of the International Monetary Fund (IMF) stated that El Salvador’s use of Bitcoin as legal tender has caused some macroeconomic, financial and legal issues that need to be carefully analyzed. Developments of these issues are being closely monitored and will continue to be conducted with the corresponding authorities. So, will Bitcoin become the legal tender of El Salvador? will it make it an emerging financial center in the world, and what impact will it have on the existing international monetary system?

The Bitcoin Law and the President of El Salvador Nayib Bukele

Is Virtual Currency a Currency?

The "currency" in modern economics generally refers to the "bank currency" under the central bank and commercial banking system. However, from a broader perspective, there is actually no standard definition for the interpretation of currency, and the evolutionary history of currency is continuously contributing to the update and improvement of the definition of "currency".

Regarding the relationship between virtual currency and currency, it is necessary to first determine whether virtual currency conforms to the legal definition of currency and satisfies all the economic functions of currency, such as value storage, medium of exchange, and accounting unit. Second, is it more widely used than other privately issued currencies in history, and can (or should) these privately issued currencies replace national currencies?

In theory, after the end of the Bretton Woods system, the high inflation rate in the 1970s renewed some people's suspicions about granting monopoly power to the central bank. Some people once again doubted the monopoly power granted to the central bank to issue non-convertible legal tender. This has led other researchers to consider a laissez-faire styled monetary system, and there is also a lot of theoretical work on the feasibility and optimality of privately issued currencies under monopoly or competitive conditions.

In the long history of currency development, the virtual currency represented by Bitcoin is not the first example of a currency issued privately in a decentralized manner. Although venture capital is very different from national currencies, the monetary system and the legal concept of currency have undergone great changes over time and will continue to change in the future.

As a type of virtual currency, cryptocurrency is stored in a digital wallet that is related to a corresponding encryption key. The public key is used to encrypt data. Its function is similar to that of an account. The private key is required for decryption; its function is similar to accessing cryptocurrency and providing the password or signature of the authentication transaction. If no intermediary is involved, the loss of the private key will actually result in the loss of the crypto assets in the wallet as the owner of the digital wallet cannot access its content any longer. Wallets can be held online (hot storage) or offline (cold storage), the latter is believed to provide greater protection against hacker attacks and theft.

Why did El Salvador Choose Bitcoin?

As early as 2001, El Salvador pegged its currency to the U.S. dollar, ending the long-standing instability that continued until the 2020 Covid-19 epidemic. The epidemic has dealt a heavy blow to the global economy. In order to revive the economy, countries around the world have loosen their policy measures, especially the United States, which has greatly increased the supply of US dollars in circulation. The data shows that from February last year to May this year, on the basis of the M2 currency stock as the standard benchmark, the circulation of US dollars has increased by nearly 5 trillion US dollars.

2020.2-2021.5 USD Circulating Supply Chart

In order to alleviate the negative impact of the US Federal Reserve, El Salvador tried to find a new way out and aimed its sights on the heated crypto market. If there is a currency supply that is not controlled by any central bank in the world and is issued according to objective and calculable standards, the crypto market is undoubtedly the best range, and the constant supply of 20 million bitcoins can be the largely getting rid of the influence of U.S. dollar or other legal tender to a maximum extent.

In the view of the Salvadoran government, there are several reasons that prompted them to propose and pass the "Bitcoin Law."

According to Article 102 of the Constitution of the Republic, the state is obliged to promote and protect private enterprises and create the necessary conditions for increasing the country’s wealth, benefiting most residents.

According to Decree No. 201, published in the Official Gazette, Volume 241, Volume 349, on December 22, 2000, the U.S. dollar was passed as legal tender.

Approximately 70% of the population does not have access to traditional financial services.

The state has an obligation to promote the financial tolerance of its citizens in order to better protect their rights.

In order to promote the country’s economic growth, it is necessary to authorize the issuance of a digital currency whose value is in full compliance with free market standards, so as to increase the country’s wealth and benefit the vast majority of residents.

Based on previous considerations, it is necessary to issue basic rules to regulate the legal process of Bitcoin.

Although El Salvador is the first country to designate Bitcoin as a legal tender, many Caribbean and Central American countries have opened their crypto investment markets ahead of time, and are good at attracting global investment with low tax rates and effective regulatory policies. If El Salvador wants to become an emerging financial center, it still needs to improve multi-faceted measures including policy preferences and market supervision, while widely embracing global crypto capital.

On the other hand, El Salvador is not the only country considering Bitcoin as its legal tender. As more countries make this a reality, El Salvador will face extremely fierce competition. At present, there are different attitudes towards cryptocurrencies around the world, which is also one of the unstable factors. In short, no currency market has eternal stability. In a relatively new and active market, healthy competition from multiple parties may be able to create the ultimate "ideal country” for currencies.

What Impact will It Have on the Existing International Monetary System?

For a long time, people have expected to create an international reserve currency that "disconnects from sovereign countries and can maintain long-term currency stability" to avoid the shortcomings of the US dollar as an international reserve currency. Bitcoin was born out of the distrust of legal currency.

Traditional financial service industries often use banks and other third-party financial institutions as carriers, with complicated operating procedures and long service cycles, and related service costs remain high. Bitcoin adopts decentralized blockchain technology. Point-to-point transactions weaken the centralization of financial institutions and create a more inclusive financial system; it provides equal financial services to underdeveloped regions and greatly reduces cross-border financial services. Payment cost can realize all-day long payment and fast transaction.

Throughout the history of global currency development, not every currency is suitable for internationalization. Judging from the existing international monetary system, the globalization experience of the US dollar is particularly worth learning. In the initial stage of currency globalization, currency must be collateralized to shape its value, thereby establishing the trust and acceptance of currency use by countries and their people. Later, currency must have a wide range of circulation application scenarios and stimulate network effects to allow currency to be used. It should also be noted that the currency-using authorities must actively participate in maintaining the stability of the currency value. Once the market turbulence occurs, a substantial depreciation or appreciation of the currency value will trigger a "currency crisis."

Looking back at the birth of Bitcoin, its purpose may not be to create a super-sovereign currency, but with the expansion of value consensus and the expansion of the scope of circulation, Bitcoin may evolve into a super-sovereign currency. At present, Bitcoin is about to be used in the form of legal currency for the first time in small countries with relatively weak financial systems. During this period, the impact of Bitcoin currency circulation on international sovereign currencies is relatively limited, as to whether it can evolve into an international mainstream currency or become a super-sovereign currency, we still need to pay close attention to the circulation of Bitcoin in small countries.


El Salvador's Bitcoin Law

International Monetary Fundation Report

Evergrande Research Institute: Blockchain Digital Currency Research Report

Author: Researcher: Jacky.S

*This article only represents the views of researcher and does not constitute as any investment advice.

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