Can Cryptocurrencies Be Legal Tender? A Case Study From El Salvador

6 views 9:43 am 0 Comments January 1, 2024

In El Salvador, preference for cash and privacy fears deterred the widespread adoption of Bitcoin as an everyday currency, researchers report. The findings suggest that policies incentivizing cryptocurrency adoption as legal tender will likely fail unless populations are financially literate and already trust digital currencies.

The introduction of digital currencies is one of the most important developments in monetary economics in the last decade. Unlike traditional digital currencies, which rely on central authorities such as governments or banks governed by regulations to mediate security and transactions, cryptocurrencies like Bitcoin use sophisticated cryptography and a decentralized network to ensure verifiable transactions.

It’s argued that cryptocurrency may offer solutions for the unbanked or those reliant on remittances. However, cryptocurrencies have yet to be widely adopted for financial transactions, and the barriers that have kept them from becoming mainstream mediums of exchange aren’t fully understood.

Here, Fernando Alvarez and colleagues leverage a unique natural experiment to evaluate these questions – the adoption of Bitcoin as a legal tender in El Salvador.

In 2021, the Salvadorian government formally recognized bitcoin as a legal tender and made it law that bitcoin must be accepted as a means of payment for taxes and debts. The government required all businesses to accept bitcoin as a medium of exchange.

To facilitate this, the Salvadorian government launched the app “Chivo Wallet” to allow users to digitally trade and exchange both Bitcoins and US dollars. Alvarez et al. developed a nationally representative, face-to-face survey of 1,800 households across El Salvador and analyzed data encompassing all transactions made over the Chivo Wallet.

The authors found that digital payments and Bitcoin use have been generally low and have declined since its introduction as legal tender, despite the government’s efforts to incentivize its use. According to the findings, Salvadorians prefer tangible cash and had concerns about Bitcoin’s privacy and transparency, which is notable given that these are two areas decentralized cryptocurrencies aim to address. Both factors impeded Bitcoin’s widespread adoption by El Salvador’s population at large.

What’s more, the authors’ survey highlighted that Bitcoin was most used by the already wealthy, financially literate and banked, which starkly contrasts with the recurrent hypothesis that the use of cryptocurrencies may help the poor and unbanked the most.

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