Almost everyone in the cryptocurrency space is happy over El Salvador accepting Bitcoin (BTC) as legal tender. I think this move is going to be negative for cryptocurrencies in general. I will lay out my arguments on why I think El Salvador's legal tender move may lead to a lot of undesired effects.
What is legal tender?
According to Merriam-webster, A legal tender is, "money that is legally valid for the payment of debts and that must be accepted for that purpose when offered."
In short, A legal tender is an asset/payment system that the state forces on merchants through law. This practice naturally leads to problems but it leads to more problems with bitcoin given the shortcomings of the base layer of BTC.
The problems of accepting BTC as legal tender
Here are the major problems I see in adopting BTC as legal tender for a whole country.
1. Self-Custody is discouraged
One of the famous sayings in the crypto space is, "Not your keys, Not coins." The intent of this phrase is to educate newcomers that if your coins are not spendable with the private keys that you have access to then they are not your coins at all. You are giving up custody of your cryptocurrency and you are possibly at the mercy of another entity that might or might not let you withdraw your cryptocurrency.
These custodial solutions are not only encouraged by the BTC chain but they are necessary to use the BTC chain. Without those custodial solutions, BTC is simply dysfunctional for everyday payments. The average value of more than half of the daily payments that happen around the world is less than 10 USD. In comparison, the average fee for a single on-chain BTC transaction can get up to 20 USD. To avoid these huge fees on each transaction, users and merchants will be forced to use second-layer solutions like the lightning network.
2. The lightning network
The lightning network is the much-hyped solution for the high fees and slow transaction confirmation problems of BTC. One of the big problems with the lightning network is that it mimics the existing financial system and takes away a lot of benefits that come from using a decentralized peer-to-peer cash system.
For example, Payments in the lightning network can be censored while on-chain BTC payments cannot be censored.
3. Centralized custodial service may lead to fractional reserve systems
When users don't have custody of their funds and when they are forced to trust a third-party service for holding their funds. The next step for the custodial institutions is usually to adopt a fractional reserve system. When such a system goes into practice most of the evils that come from the existing financial system will just continue as usual.
4. The risk to national sovereignty
Since most of the economic activity of El Salvador is going to happen on the lightning network. The economy of a whole country is overly reliant on a software stack developed by a single company called Blockstream and the money has to go through financial companies that the country has no control over. This scenario poses a great threat to the national sovereignty of El Salvador.
5. Forcing merchants
When something is a legal tender, merchants should accept it in exchange for goods or services. While forcing a whole country into using a product may seem appealing to some, this whole strategy can backfire when merchants face trouble when using it in real-world solutions. Lost funds, censored payments or losing money due to user error can be a few adverse events that may happen. These events may cause the merchant community to entirely close their eyes to other better working cryptocurrencies in the future.
Why is it bad for cryptocurrencies?
The above-mentioned flaws are very specific to the Bitcoin BTC version. The people of El Salvador may experience a completely different user experience if they adopt a different cryptocurrency. However, since they are going to be exposed to BTC with all its flaws first, they may dismiss cryptocurrencies altogether if this effort fails to gain traction.
In conclusion, I believe encouraging merchants to voluntarily accept a cryptocurrency of their choice at their own risk is the right approach to prepare for a future that is full of possibilities.
Agreed.
Wait, what? No, the above doensn't affect merchants at all. Merchants trade good and services, they do not deal in debt. Those that do are part of the financial system and follow very different laws.
Normal merchants and traders are not affected by "legal tender" laws. They are not obligated to accept BTC.