Bitcoin Became a Legal Tender in El Salvador

In News

• Recently, El Salvador became the first country to adopt bitcoin as legal tender, although it suffered teething problems when the government had to unplug a digital wallet to cope with demand.

What is the rationale for using Bitcoin in El Salvador?

• Addresses effects of Central Banks: Central banks are increasingly taking actions that may cause harm to the economic stability of El Salvador so Bitcoin was being adopted in order to mitigate the negative impact from central banks and remain at par on the purchasing power front, it becomes necessary to authorize the circulation of a digital currency with a supply that cannot be controlled by any central bank.
• Saves Remittances: The country’s economy is heavily reliant on remittances from its citizens working abroad. According to World Bank data, remittances made up about 20% of the country’s GDP — one of the highest ratios in the world. By enabling the transfer of money via Bitcoins, citizens will save on transaction fees of banks and agencies. 
• Protection by Government: The government will protect citizens from the volatility of Bitcoin prices by guaranteeing quick convertibility to dollars. E.g. If a shopkeeper does not want to hold the Bitcoin which they now have to accept from customers, the government will purchase it through a $150million trust created at the country’s development bank. 
• Managing Carbon Footprint: As for the carbon footprint, the State-owned geothermal electric company, LaGeo, to connect renewable energy from the country’s volcanoes to bitcoin mining facilities.

Cryptocurrency

• It is a specific type of virtual currency, which is decentralised and protected by cryptographic encryption techniques – blockchain technology, a system of distributed, cryptographically secured account keeping. 
• In this system, the users keep a tab on every digital ‘coin’ and transaction rather than a banking system with a governing body at its centre. 
  • Examples: Bitcoin, Etherium, Tether, Ripple and Binance Coin

Working of Cryptocurrency

• They are Decentralised. It implies that there is no central authority where records of transactions are maintained.  
• Instead, anyone can create a transaction.  
• This transaction data is recorded and shared across multiple distributor networks, through independent computers.
• This technology is known as Distributed Ledger Technology (DLT).

   Image Courtesy: GAO

Applications of Distributed Ledger Technology (DLT)

Benefits of Cryptocurrency

• Inherent Security: The use of pseudonyms and ledger systems conceals the identities.
  • It uses cryptography technology which is almost impossible to break.
  • A transaction done by cryptocurrency is irreversible and cannot be reversed.

• Low Transaction Cost: Very low fees and charges for transactions.
• Lack of Interference from Banking System: Outside ambit of banking systems.
  • There is no gatekeeper like that of government and central banks and users are responsible for all the transactions.

• Lower Entry Barriers: No entry barriers, unlike conventional banking systems.
  • The transaction is instantaneous and since the network is global, the transaction can be done across the globe without restrictions.
  • It could provide Faster transactions. 
    • For example, they can be used for small value cross-border transfers where the cost of sending remittances remains high due to multiple intermediaries.  

• Universal Recognition: Lots of cryptocurrencies and acceptable in many nations.
  • The transaction is instantaneous and the transaction can be done across the globe without restrictions.
• Other benefits 
  • Improve access to credit, more transparency in transactions, provide improved ease of auditing.

Issues with Cryptocurrencies

• Threat to centralised control: Due to their core nature that shuns centralised control, governments globally have been wary of cryptocurrencies. 
• Highly volatile: Cryptocurrencies are highly volatile and have high fluctuation rates. The price of virtual currencies is a matter of mere speculation resulting in spurt and volatility in their prices.
• Reluctance from Governments: Most governments have warned their citizens against investing in cryptocurrencies, let alone allowing transactions in them.  
• Security Risks: The increasing popularity will promote the use of Cryptocurrency or Bitcoin, in particular, opening ways to fraudery and as an alternative to Fiat Currency.
  • They are prone to issues like Hijacking, Routing Attacks, Distributed Denial of Service (DDoS) attacks.
• Increasing pollution due to its working mechanism: The ‘mining’ of Bitcoin, where individuals or companies set up powerful systems to support the blockchain network, for which they are rewarded in the currency, consumes huge amounts of energy and produces million metric tonnes of carbon dioxide emissions a year. 
• Compliance of FATF Guidance: With large scale cryptocurrency inflows and outflows, it would be expected from countries to comply with the 2019 Financial Action Task Force (FATF) guidance on Virtual Currencies.
• Lack of Liquidity and Lower Acceptability: Outside the traditional banking systems.
• Lack of Consumer Protection: No dispute settlement mechanisms.

Way Forward

• Despite all its risks, Cryptocurrency is perhaps the most exciting asset of the 21st century. A decentralized digital currency that works on the very interesting and likely here-to-stay blockchain technology. 
• Establishing safeguards, measures and regulations after taking inspiration from developed countries.
• Some of the cryptocurrencies have seen a massive dip in their per-unit trading prices lately, leading to erosion of investor wealth. Some investors have been looking at cryptocurrencies as an attractive investment class.
• The overall takeaway for India from the El Salvador case is not in the monetary sense at all but as an example of how far countries are willing to go to attract innovators and entrepreneurs working on this emerging sector. 
• This is the wealth that India has in spades and has barely protected with policy. 
• While deliberations continue in India on the monetary and financial regulations around cryptocurrency, it is important that attention be paid to incentives for India’s developers working on key innovations in the space.

Sources: IE