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Cryptocurrencies as a legal tender

  • Published
    14th May, 2022
Context
  • A transition towards cryptocurrencies by the Central African Republic and El Salvador is spurred by the urge to circumvent inflationary pressures and move away from colonial currency mechanisms.
    • The Central African Republic (CAR) became the second country after El Salvador to adopt Bitcoin as legal tender.
About
  • The CAR is among the poorest and most economically fragile countries on the globe.
  • As per World Bank estimates provided in July 2021, 71% of its population was living below the international poverty line of $1.90/day.
  • President of CAR had said that this measure would enable “strong and inclusive growth” and place the African country on the “map of the most courageous and visionary countries in the world”. 
  • The International Monetary Fund (IMF) said adopting the unregulated asset as a legal tender posed major legal, transparency and economic policy challenges.
  • Several countries have considered instituting laws that regulate the use of cryptocurrencies, particularly those not having well-devised currency mechanisms and experiencing prolonged inflation.
  • Geopolitical currents and dependence on varied colonial-era currencies have further provided stimulus. 

What is Cryptocurrency?

  • Cryptocurrency, sometimes called crypto-currency or crypto, is any form of currency that exists digitally or virtually and uses cryptography to secure transactions.
    • Cryptocurrencies don't have a central issuing or regulating authority, instead using a decentralized system to record transactions and issue new units.
  • It is a digital payment system that doesn't rely on banks to verify transactions. 
    • It’s a peer-to-peer system that can enable anyone anywhere to send and receive payments.
  • Instead of being physical money carried around and exchanged in the real world, cryptocurrency payments exist purely as digital entries to an online database describing specific transactions.
    • When you transfer cryptocurrency funds, the transactions are recorded in a public ledger. Cryptocurrency is stored in digital wallets.

It’s Impact on Economy of African nations

  • Can doge the inflation: There is potentially a direct relationship between inflation and countries permitting the use of cryptocurrencies.
  • Cryptocurrencies bear the potential to convert inflation-related headwinds from legal currencies into tailwinds.
  • The purchasing power of the dollar takes a hit because of the price rise.
  • However, Bitcoin, which say rose 10% the previous day and is unaffected by the local conditions, would endow greater purchasing power to the consumer and dodge inflation.
  • Can reduce Headline inflation: according to the IMF, headline inflation in the African countries is expected to accelerate to 4% in 2022 because of rising food and fuel prices.
  • Food, fuel and budget support shocks are also expected to weaken the country’s balance of trade.

Risks associated for those countries

  • Despite a strong economy, El Salvador’s public debt remains persistently high.
  • “This situation is unsustainable—it crowds out private investment and limits resources for social and infrastructure spending, all impediments to growth,”.
  • The country would essentially require more private investments and healthier public finances.
  • For countries like CRA, risks associated with paying taxes in cryptocurrencies would be exposed when taxes are paid using crypto-assets but expenditures remain in local currency.
  • For example, the government collects $100 worth taxes using crypto denominations but a downward slide of the asset makes available $40 to spend.
  • Unlike equities or currencies, cryptos are not subject to a definite mechanism and are speculative assets, therefore, central banks would not have any reference point to devise their interest rates in accordance with their domestic requirements. 
  • The IMF argues that the underlying anonymity in crypto-transactions may create certain data gaps for regulators.
  • Blockchains may help trace the transactions but not the parties involved. Hence, it could potentially be used for money laundering, terrorist financing or other illegal activities.

Some types of cryptocurrency

  • Bitcoin
  • Ethereum
  • Ripple
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