The future of crypto as legal tender

When we look back on the historical performance of El Salvador’s economy, we see that it has been plagued with instabilities and a stubbornly low GDP growth rate. Despite the dollarization of its economy in 2001, unrelenting problems continued to keep its economy in turmoil. In June 2021, in a revolutionary move, El Salvador introduced a bill in its legislature to make Bitcoin legal tender. This bill received majority support from the house, making Bitcoin legally acceptable as a mode of payment in El Salvador through Chivo, its government powered Bitcoin wallet. Why did this seemingly underdeveloped economy decide to embrace cryptocurrency, when some of the largest economies of the world continue to be skeptical of it?

In the past, El Salvador’s government had tried to revive its economy by adopting the US Dollar as legal tender, alongside its native currency, the Colón. However, the plan backfired, causing massive inflation and the complete cessation of circulation of the Colón by 2004. El Salvador’s decision to legalize Bitcoin is being seen as the nation’s second attempt at avoiding the financial crises caused in the country by frequent devaluation of its national currency, by adopting alternative currencies which enjoy greater value and stability. More than two million El Salvadorians were using the Chivo wallet within two months of its launch. This popularity can also be attributed to the increased use of cashless, or digital payment methods during the lockdowns owing to the COVID-19 pandemic.

Crypto and Central Bank Digital Currencies (CBDC) can flourish in developing economies under the right conditions. Due to lower penetration of banking and credit cards in these markets, more and more people have shifted to mobile payment platforms, especially during the pandemic. This has been documented in the rise of payment applications such as Mercado Pago in South American nations, Jumia Pay in African countries and Alipay in China. Developing economies , therefore, show huge potential for harboring a booming digital currency ecosystem. However, whether these digital currencies would be in the form of crypto coins, or CBDCs, is a matter of their government's priorities and public support.

While developing nations would benefit tremendously by adopting digital assets in the form of crypto currencies, these economies already face volatility and instability due to weak native currencies, rampant cyber crime, fraud, money laundering and tax evasion activities. In such circumstances, the veil of anonymity that a user naturally enjoys while transacting through cryptocurrency wallets can exacerbate these financial crimes and frauds. The volatility of crypto coins can also cause financial losses to the degree that these growing economies just cannot sustain. Therefore, to circumvent these risks, developing countries may choose to issue CBDCs in place of unregulated crypto currencies.

More than eighty one countries around the globe are experimenting with CBDCs. Many popular blockchains, such as Algorand, Ethereum and Cardano offer blockchain infrastructure to central governments to develop their own CBDCs. Since CBDCs are regulated, they eliminate the risk factors posed by crypto currencies, while allowing nations to reap the fruits of blockchain technology. CBDCs can protect national currencies from being counterfeited. They can also make cross border payments incredibly cost effective. Regulation of CBDCs makes them trackable, which can prevent them from being used in fraudulent or illegal transactions. CBDCs are pegged to a nation’s fiat currency, hence, they are not suitable as investment options due to their stable value. In fact, the use of CBDCs in speculative trading activities might even be discouraged. Since CBCDs are not volatile, and have the backing of national regulatory authorities, they would enjoy greater acceptance and adoption even by skeptics. Theoretically, CBDCs are much more scalable when compared to crypto, due to their large, regulated database.

However, there are some key differences between crypto and CBDCs which culminate in debilitating consequences for the principles that form the basis for the creation of digital assets, mainly cryptocurrencies. Firstly, CBDCs are centralized. The blockchain ledger of CBDCs is permissible, or in other words, it is private. Only authorized network nodes can participate in the recording of transactions, and the creation and validation of new blocks. This defeats the entire purpose of decentralization - a key property of blockchain based currencies. Secondly, while the lack of anonymity in CBDCs might reduce frauds, a central bank will have the power to track , as well as hinder the activities of any user it wants to. The economical inclusivity and accessibility which was ushered by DeFi, will dissipate once again as lending and borrowing through CBDCs will be regulated.

CBDCs can be used by central authorities to leverage the advantages of blockchain technology, while preventing the mass adoption of unregulated crypto currencies. An autocratic government might easily use CBDCs as a means to capture the digital currency market with an iron grip of control. China’s CBDC seems to be designed to serve these very purposes of governmental supremacy and control. The RBI’s negative stance on cryptocurrency and its continuous threats to ban their use, also points in this direction. As restrictive policies and institutionalization of cryptocurrencies become common practice, the rising interest and support of CBDCs may bring an end to the short lived utopia of decentralization in finance.

In conclusion, there is a very thin line between regulation and control. CBDCs are essentially the digital forms of fiat currencies. They are plagued with the same issues that cryptocurrency was created to solve. Lawmakers around the globe are increasingly skeptical of cryptocurrencies replacing fiat money. CBDCs are a step towards taming the unregulated beast that crypto currency has proven to be. Governments are wary of losing authority over the monetary system of their countries. Although cryptocurrency faces genuine setbacks of its own, decentralization is a noble pursuit which faces the threat of once again being cast aside due to the public’s tendency to gravitate towards familiar, seemingly reliable modes of currency such as CBDCs. It is important, therefore, for crypto developers to proactively innovate solutions to tackle the issues regarding volatility and fraud that cryptocurrencies are often associated with, if cryptocurrency is to ever have a real shot at becoming legal tender.

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