Bitcoin Became a Legal Tender in El Salvador

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    • 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.

    El Salvador

    • El Salvador, the country of Central America. It is the smallest and most densely populated of the seven Central American countries. Despite having little level land, it traditionally was an agricultural country, heavily dependent upon coffee exports.
    • El Salvador is bounded by Honduras to the north and east, by the Pacific Ocean to the south, and by Guatemala to the northwest. Its territory is situated wholly on the western side of the isthmus, and it is, therefore, the only Central American country that lacks a Caribbean coast.

    Currency of El Salvador

    • El Salvador fully ‘dollarized’ its economy in 2001 to-
      • take advantage of the stability that it offers and attract investments.
      • get linked to the monetary policies of the FederalReserve in Washington.
      • prevent hyperinflation in the economy

     

                                                           Image Courtesy: Britannica

    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

    Bitcoin

    • Bitcoin was launched in 2009 by Satoshi Nakamoto.
    • It is a type of digital currency in which a record of transactions is maintained and new units of currency are generated by the computational solution of mathematical problems, and which operates independently of a central bank.
    • It is the first and biggest of decentralised cryptocurrencies, which are online payment systems. 

    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

    Countries on use of Cryptocurrencies

    Country

    Regulatory Framework

    Canada

    Permitted as a payment system and as a form of investment, income from it is taxed

    Switzerland

    Permitted as a payment system (including consumer to government transactions) and as a form of investment

    Japan

    Permitted and regulated as a payment system

    China

    The use of cryptocurrency is banned for all purposes

    Applications of Distributed Ledger Technology (DLT)

    Sector

    Possible uses of DLT

    Payments

    Faster and cheaper cross-border payments

    Reduced transaction cost for micro-payments

    Identification

    Storing personal records such as birth, marriage or 

    death certificates

    Removing duplicates in identification platforms such as KYC

    Insurance

    Fraud detection and risk prevention

    Claims prevention and management

    Ownership registries

    Removing errors and frauds in land markets

    Administrative ease of maintaining land records

    Trade Financing

    Reduced operational complexity and transaction costs

    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.

    India and Cryptocurrency

    • 2013: RBI issued a warning to individuals dealing with virtual currencies in India on the financial, legal, operational and security-related risks
      • The Government set up a committee chaired by the Special Secretary (Economic Affairs) with the goal to
        • Take stock of the present status of Virtual Currencies both in India and globally.
        • Examine the existing global regulatory and legal structures.
        • Suggest measures (related to consumer protection, money laundering, etc). 
    • 2017: The Ministry of Finance issued a statement that clarified that virtual currencies are not legal tender and do not have any regulatory permission or protection in India.
    • In the budget speech of 2018-19, the Finance Minister announced that the government does not consider cryptocurrencies as legal tender and will take all measures to eliminate their use in financing illegitimate activities or as a part of the payment system.
    • In 2018 The RBI had first come out with a circular on the issue, cautioning people about investing in cryptocurrencies, which do not have any sovereign character.
    • It had barred entities regulated by it from dealing in such instruments. 
    • 2019: Inter-ministerial committee recommended ban all private cryptocurrencies.
    • 2020: Supreme Court struck down the ban as unconstitutional.
      • Court’s observation: RBI has not come out with a stand that any of the entities regulated by it, namely, nationalised banks/scheduled commercial banks/cooperative banks/NBFCs, have suffered any loss or adverse effect directly or indirectly, on account of virtual currencies (VCs).
        • Hence, the RBI circular is “disproportionate” with an otherwise consistent stand taken by the central bank that VCs were not prohibited in the country.
        • The court found that the RBI did not consider the availability of alternatives before issuing the circular.
        • The court referred to the Centre’s failure to introduce an official digital rupee despite two draft Bills and several committees.
    • 2021: Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 introduced.
      • Under this plan to ban private digital currencies, favour RBI backed currency.
      • A 3-6 month exit period prior to banning the trading, mining and issuing of cryptos.
      • Finally, Cryptocurrencies, though unregulated, are not illegal in India.

    RBI and Digital Currency

    • Exploring DLT (Distributed Ledger Technology) based Central Bank Digital Currency. 
      • Under DLT, details are recorded in multiple places at the same time.
    • Central Bank Digital Currency (CBDC): It will be a legal tender.
      • Can be converted/exchanged at par with similarly denominated cash.
    • Need for Central Bank Digital Currency (CBDC): Need-Innovations are changing the payments space rapidly. 
      • This has made central banks around the world examine whether they could leverage technology and issue fiat money in digital form

    Sources: IE