Bitcoin Adoption: What Exactly is a Legal Tender?

Beginner Oct 21, 2021 · 5 min read

Key Takeaways:
— Legal tender is a nationally accepted medium of exchange that is issued by the national government. However, some nations with weaker economies and hyperinflation are forced to rely on and use currencies of other stronger economies such as the U.S. as legal tenders. 
— The rising awareness about cryptocurrencies has caused these nation-states with weaker economies to consider alternatives to fiat currencies. And the obvious first choice seems to be Bitcoin.
— Recently, the Central American nation El Salvador even accepted Bitcoin as legal tender, becoming the first nation worldwide to do so. But the question still remains, can Bitcoin make a suitable legal tender? 
— In this article, we will understand the meaning of legal tender, dive into why countries consider making other country’s legal tender their own, and can Bitcoin make a suitable legal-tender alternative to state-back currencies?

El Salvador has made Bitcoin legal tender – but what is legal tender? And Can we all use Bitcoin?

For most of us from stable economies, losing a part or whole of the value of our life-long savings overnight can be an alien concept. It may sound strange to use some other country’s legal tender as our own. But that’s the fate millions of people from smaller, developing economies face. To blame, we have hyperinflation.

Hyperinflation and the need for a new legal tender

If you were a citizen of Zimbabwe around 2007-08, all your savings in Zimbabwean dollars would’ve lost 99.99% of its value by 2009 — courtesy of an inflation rate as high as five billion percent. So, while you’d still be having notes of 10 and 100 Zimbabwean dollars, the country would be issuing trillion dollar bills such as the one below.

Similar to Zimbabwe, the unstable economy of many developing countries pushes them to rely on one or multiple foreign currencies instead of their own. Very often, the obvious option for them is to use the world’s reserve currency, the U.S. dollar, as legal tender. Today, countries like El Salvador, Zimbabwe, Puerto Rico, and Panama officially use the U.S. dollar as legal tender.

But cryptocurrencies such as Bitcoin are turning the tides. Governments of developing nations are considering adopting Bitcoin as legal tender instead of using the U.S. dollar or any other state-backed currency. For most people, this change begs the question: what makes Bitcoin a suitable legal tender for national economies?

We’ll dive into that, but first, let’s understand what a legal tender is.

What’s a legal tender?

You wake up in the morning, go for a run, and on your way back, stop at the Starbucks to grab your morning latte. Then you stop by the grocery store to buy some cereal, bread, and milk.

What you use to settle these transactions depends on where you’re living. If you’re in the U.S., you use the U.S. dollar. Anywhere in the European Union, you use the euro. Or, if you’re in El Salvador, then you have a couple of options; the US dollar or in that case Bitcoin. And that is what the legal tender of your country is. 

To put it simply, a legal tender is anything that the governing body of a country legally accepts as a suitable medium of exchange for settling all kinds of transactions within the country. Besides, the law may also restrict citizens from using anything other than the specified legal tender as a medium of exchange within respective countries.

However, a country may not always print its own legal tender, as is the case in dollarized economies such as that of El Salvador. Instead, another country with a more stable economy like the U.S. may print and delegate its currency for the citizens to have a more stable medium of exchange.

The problem with existing legal tenders

The value of a traditional legal tender is governed by how well a government is performing and how effective its policies are, both domestically and internationally. If your government fails to perform well by international standards, the value of the currency can fall drastically, causing high levels of inflation. Besides, fiat currencies as legal tender offer limited flexibility as they are centered around a central entity and are accepted only within specific geographic boundaries. 

Further, countries that use currencies of other nations as their legal tender are only burdened with more economic pressure, pushing them into a spiral of never-ending economic misery. This is leading a number of countries to consider Bitcoin as a more flexible alternative. So, let’s take a look at what’s so attractive about Bitcoin.

Is Bitcoin a suitable legal tender?

Since El Salvador accepted Bitcoin as a legal tender, the arguments about Bitcoin’s effectiveness as legal tender have grown intense.

Bitcoin price spikes to $51k, highest since May 2021 | news.com.au —  Australia's leading news site
Image credit: news.com.au

Some believe that using Bitcoin as a medium of exchange is highly risky for common people due to its short-term price volatility. Others say that Bitcoin is not for everyone as not everyone can afford to pay its high transaction fees. Besides, the mainstream media has made it quite apparent that Bitcoin consumes electricity equivalent to some nation-states. Some also fear that Bitcoin’s anonymity will offer criminals a safe circle to exchange money and fund illegal activities. 

So, given these concerns, does it still make sense to use Bitcoin as legal tender? 

There’s no straightforward answer to that, but there are solid reasons why Bitcoin can actually be an effective legal tender. But there also are drawbacks. We’ll take a look at both.

What makes Bitcoin an effective legal tender?

1. Resistant to Inflation: Bitcoin has a fixed supply of 21 million coins and it cannot be printed like fiat currencies. This makes it resistant to inflation, and the funds you hold in Bitcoin cannot be devalued from “money printing”. 

Further, Bitcoin has existed for over 11 years now, and it has had only two years where its overall annual change in value lurked in the negative. Contrarily, currencies of countries that are considering adopting Bitcoin have faced severe inflation, causing a nationwide loss of livelihood, which makes Bitcoin a far better alternative. 

2. Efficient Unit of account: By definition, a unit of account is meant to measure the value of something. In that regard, Bitcoin can be a suitable one. That’s because one Bitcoin equals 100,000,000 satoshis. And we can easily use satoshis to denominate the value of goods and services of the smallest scale.

3. Fast and Cheap Transactions: If we speak of transaction speed and costs, Bitcoin is one of the fastest and cheapest ways to transact value anywhere in the world, thanks to Lightning Network

The cost-effectiveness of Bitcoin transactions on the LN makes Bitcoin highly suitable for weaker economies with substantial inflow of remittances. If citizens are able to receive Bitcoin payments from their family members working abroad, it can save hundreds of millions in fees paid to banks and financial service providers.

4. Easily Accessible to All: According to the World Bank, more than 1.7 billion adults globally are devoid of traditional banking services. It’s no surprise that a majority of these unbanked people are from developing countries across Asia, Africa, and Latin America. Adopting Bitcoin as a legal tender can offer an easier alternative to opening bank accounts in order to make banking services available to them. That’s because anyone with a smartphone can access and use Bitcoin-related services.

5. On Track to Becoming Green: It’s true. Bitcoin does consume energy equivalent to a small country and its energy demand is expected to only go up from here. But what’s noteworthy is that more Bitcoin proponents are starting to rely on renewable sources of energy. If we are to trust some vague estimates, anywhere between 30% to 60% of the energy consumed by Bitcoin comes from renewable resources.

Even if the numbers are smaller, there are initiatives being taken to make Bitcoin more eco-friendly. For instance, soon after the adoption of Bitcoin as legal tender, El Salvador announced its plan to use the energy produced from its volcanoes to mine Bitcoin. We’ve not seen anything more eco-friendly than that, have you?

6. Transparent: If at all, Bitcoin transactions are pseudonymous. The details of every Bitcoin transaction, from sender and receiver wallet addresses to the amount paid, get listed on a transparent, public ledger. So, it’s factually incorrect to accuse Bitcoin of being an anonymous currency for criminals. For someone seeking true anonymity of their transactions, cash would be a much better alternative as it leaves no trace.

Even data from a 2021 Chainalysis report showed that in 2019, only 2.1% of all cryptocurrency transactions represented criminal activity. In 2020, the percentage further dropped to just 0.34%.

Downsides of Bitcoin as legal tender

This is the second side of the coin we have to face no matter how much we may like Bitcoin. Like any other currency or medium of exchange in existence, Bitcoin has its set of drawbacks. 

The most commonly discussed drawback of Bitcoin is its volatility, but that’s subjective to the fact that we compare it in the short term with a fiat currency. What’s more critical is the technical understanding one must acquire before using Bitcoin as a mode of payment. While most people today can use a smartphone, using Bitcoin can still require some education. Further, one more considerable issue is Bitcoin’s reliance on the internet, which sets it a step behind cash as it cannot be used in regions with poor or no internet connectivity. 

Apart from these, what we mostly have are challenges, not drawbacks. Some of these are the concerns regarding Bitcoin’s exposure to cyber threats, issues with tax calculations, lack of wide adoption, and so on.

Can the future be Bitcoin?

Despite some challenges, people and governments have finally started seeing the true potential of Bitcoin. Whether all countries accept it as a legal tender in their country or not is still up for debate, but the change is happening. After El Salvador made Bitcoin legal tender, countries across Latin America and beyond have started considering that possibility. On the list are Panama, Paraguay, and Mexico, with others expected to soon start publicly displaying their intent to adopt Bitcoin as legal tender.

All in all, Bitcoin is growing bigger and more popular by the day, and what the future holds for it is surely going to be interesting. So, be ready for a roller coaster ride as the world transitions into this new age economy.

If you want to get a better grasp of Bitcoin and how it works, check out this School of Block episode!

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