When Satoshi Nakamoto wrote Bitcoin’s whitepaper in 2008, the goal was to develop a global borderless digital currency that isn’t subject to bureaucratic regulations but decentralized across several nodes worldwide. However, since its creation, Bitcoin has primarily been used as a store of value to hedge against devaluating currencies or as an investment for profit reasons. As a result, very few people see Bitcoin in the light of the Euro, U.S. dollar, Yuan, etc.
Interestingly, since last year, a few countries have been trying to return Bitcoin for the purpose it was created by making it legal tender. Since then, several debates have sprung up about the suitability of Bitcoin or any other cryptocurrency as legal tender and if they can work. This article intends to put the debate to bed.
What is a Legal Tender?
A legal tender is any item recognized by law as a viable means of debt payment or meeting financial obligations such as taxes, charges, levies, etc. Therefore, a creditor is legally obligated to accept the legal tender as a debt repayment option.
Two countries, El Salvador and the Central African Republic (CAR), have officially announced Bitcoin as legal tenders in their countries; how feasible is it? Is it sustainable? Can it work in reality?
Case study of Bitcoin as Legal Tender in El Salvador
In September 2021, El Salvador adopted Bitcoin as its official legal tender, in addition to the U.S. dollar. The Salvadoran colon had been abandoned since 2001 due to political and economic reasons. El Salvador faced a civil war that plunged the country deep into economic sabotage, loss of lives, infrastructure, and properties, leaving the company void and without anything valuable to export; as a result, the Salvadoran colon suffered, and inflation set in. To salvage the economy, the government “dollarized” the Salvadoran economy, making the U.S. dollar an official legal tender in El Salvador. This helped them curb inflation while maintaining a healthy relationship with the United States, which was by far their largest trading partner.
The dollarization of the Salvadoran economy helped to momentarily steady the ship, and many other countries that have battled hyperinflation have also gone via this route; a few examples include Zimbabwe, Venezuela, and Panama. These countries totally abandoned their currencies because they became worthless; for example, in 2008, Zimbabwe recorded a monthly inflation rate of 79.6 billion percent; hence, if you had trillions of Zimbabwean dollars saved, by the end of the year, those savings may not be worth the piggybank you kept it in.
Bitcoin, a better alternative?
Relying on the U.S. dollar as an alternative means that the economies of these countries are subject to policies made in the United States. Although the U.S. economy is pretty stable, it is not totally devoid of anti-deflationary policies; for example, 40% of all U.S. Dollars in existence were printed between 2020 and 2021, and inflation is beginning to become an issue even in the U.S. Of course, the U.S. economy is way better than any of these countries, but 9.1% inflation as of June 2022 is certainly one to worry about. Hence the question; is Bitcoin a better alternative for legal tender?
Bitcoin is a decentralized currency, not subject to the politics or economics of any country; also, it is impossible to print (or, in this case, mine) more than 21 million Bitcoin; hence, the supply is deflationary, and no government can wreck its value due to indiscriminate printing, (as occurred with the Zimbabwean dollar). As a result, Bitcoin rises with increased adoption; with each new person that acquires Bitcoin, the supply available reduces, and with soaring demand, the value of Bitcoin rises. Hence, Bitcoin seems to offer a better alternative than dollarization, or maybe not?
Bitcoin’s Volatility and Its Effect on Day-to-Day Spending
The major problem with Bitcoin is its volatility. On some bad days, Bitcoin could lose value by over 20%, and similarly, at other times, Bitcoin can embark on a massive bull run that will last for months. Hence, people don’t want to spend their Bitcoin when the price rises and don’t want to accept Bitcoin as a form of debt repayment when the price is falling. Some cryptocurrency analysts have suggested that with an increase in the price of Bitcoin, volatility will soon become a thing of the past; they argue that lower prices make the asset volatile because, for example, it is easier for an asset to move from $1,000 to $1,500 than for it to move from $100,000 to $150,000; whereas, it is the same percentage increase. Hence, they argue that in the future, when one Bitcoin is worth seven U.S. dollar figures, volatility will not be a thing to worry about, and more countries can spend it as legal tender.
Other concerns about Bitcoin as a Legal Tender
Scalability: We can often make transactions in our local currencies within a few seconds, whether via cash, cheques, or other digital payment options. However, Bitcoin transactions are much slower due to its Proof-of-Work (PoW) consensus mechanism. The Bitcoin network has a speed of 7 Transactions per Second (TPS) – in contrast, VISA has a TPS of 1,700; hence, on average, a Bitcoin transaction may take 10 minutes to complete. Moreover, in times of huge network congestion, transaction fees will soar, making it even more difficult to transact. Hence, in this regard, fiat transactions may seem preferable to the general public, who do not care much about decentralization.
It is important to note that the Bitcoin network has a scalability solution – the Lightning Network, which allows instantaneous payments; however, this scalability solution is a state channel, which is not optimal for one-off transactions.
Fraud: Many people are quite newbies regarding cryptocurrency and blockchain technology; hence, malicious attackers will always try to phish people with scandalous emails, compromise their seed phrases, or lure them into scams. Hence, many bad stories typically ward people off.
Bitcoin is an effective legal tender because of its deflationary mechanism, aiding borderless transactions, transparency, etc. However, with prevalent volatility, Bitcoin may primarily remain a store of value for many. However, we wait to see what becomes of Bitcoin as a legal tender in coming years, particularly when a single unit gets to six- or seven-dollar figures. We also look forward to seeing better scalability solutions that will make Bitcoin transactions cheaper and faster for users.