El Salvador Adopts Bitcoin But a Stablecoin May Have Worked Better

Ever since El Salvador’s president Nayib Bukele activated his laser eyes and made Bitcoin the nation’s legal tender this week, crypto communities have been gushing about this latest milestone. But in his bid to provide his citizens with more financial freedom, did Bukele pick the wrong token?

Stablecoins — cryptocurrencies that peg their value to external assets such as fiat currencies — have far less volatility than Bitcoin, plus they permit users to tap an ever-growing list of financial applications that help people manage and grow their assets. If the goal is to help Salvadorans, 70% of whom don’t have bank accounts, get vested in the financial system then these staid cousins of the racier Bitcoin might be just the ticket.

For example, users can tap popular stablecoins like USDC and DAI, both of which aim to keep their value as close as possible to $1 USD. Even better, they can utilize DeFi lending protocols like Staked to generate annual return rates over 2% for their stablecoins, which trounces the average annual return of 0.06% offered by traditional fiat savings accounts.

Let’s not forget — for all its resilience and popularity, Bitcoin is white knuckle ride for its holders. While Bitcoin’s value has grown 229% over the last 12 months, market swings in the past month alone have sent the price of Bitcoin spiraling 46%, from highs of $60k to lows of $31k, and now back up 13% in the past 24 hours to $36k.

(Image: Coingecko)

Taxable Income

That isn’t the only hurdle. There’s the issue of Bitcoin’s tax treatment. Because the IRS categorizes Bitcoin and other cryptocurrencies as “property,” any U.S. individual or business receiving Bitcoin as payment from El Salvador may have to pay a capital gains tax when the currency is converted to U.S. dollars, says Shehan Chandrasekera, head of tax strategy at cryptocurrency tracking and tax company CoinTracker.

Moreover, the Feds may look on Bitcoin payments with a Salvadoran origin as income. “If you are a U.S. citizen or a resident alien, your worldwide income is subject to U.S. income tax,” says Chandrasekera. “Therefore, when a US resident gets paid in Bitcoin for a project with an El Salvadorian company, it is income to the US taxpayer. El Salvador treating Bitcoin as a currency has no impact on this statement.”

In other words, despite Bitcoin becoming legal tender of El Salvador, it won’t make any difference to the IRS — it may be considered both taxable income when received and property tax when spent or converted.

“That said, the taxpayer can make an argument with the IRS that he/she received a foreign currency as opposed to property,” said Chandrasekera.

Signature Moment

Still, El Salvador’s leap is a signature moment in the evolution of cryptocurrencies, said Jon Matonis, a founding member of the Bitcoin Foundation.

Bukele’s legislation, which was approved with a supermajority in the Salvadoran Congress on June 9, distinguishes the country as the first in the world to make Bitcoin a legal, officially recognized currency. Bitcoin’s status as “legal tender” means it can be used to settle financial obligations like taxes. Moreover, the legislation also mandates that economic agents must accept Bitcoin as payment for goods and services, and ensures that the government will provide the private sector with training and the necessary technology to meet this goal.

For the first time, a member nation of the International Monetary Fund and an endpoint in the Swift cross border payments system has adopted Bitcoin as an official currency. While it’s unknown how or if the international banking system will accommodate El Salvador’s new digital currency regime, Matonis believes the move is also a watershed for DeFi itself. El Salvador currently uses the U.S. dollar.

Entry Barrier

While stablecoins and the Ethereum network look attractive, they may not be ready for prime time. High gas fees on the Ethereum blockchain pose a major barrier to entry for low income households. Luckily, Layer 2 scaling solutions like Polygon offer an increasingly diverse array of DeFi options, minus the high transaction fees, so it’s not hard to imagine a near-future where stablecoin farming could be accessible even to people starting out with smaller assets.

“El Salvador was wise to begin with the most proven and resilient cryptocurrency on the planet, which is Bitcoin,” said Matonis, the chief economist at Cypherpunk Holdings Inc., a privacy protocol investing firm. “This is a major step into the world of decentralized finance and the extraordinary opportunities available via additional DeFi protocols will start to become more apparent.”

LatAm Takes Note

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Other Latin American nations may slipstream behind El Salvador. Carlitos Rejala, a congressman and the National Deputy of Paraguay, said, “Our country needs to advance hand in hand with the new generation,” on Twitter, highlighting his new profile picture with Bitcoin laser eyes. “This week we start with an important project to innovate Paraguay in front of the world!”

Panama’s Independent Deputy, Gabriel Silva, voiced support for cryptocurrency as well. In May, the Mexican crypto exchange Bitso, which services customers in Mexico, Brazil, and Argentina, became Latin America’s first crypto unicorn after raising $250M in series C funding and achieving a $2.2B valuation. While Bitso offers nine cryptocurrencies, including ETH, their primary focus is Bitcoin.

Alongside El Salvador, Paraguay, and Panama, other Latin American government leaders who vocally support crypto represent Argentina, Brazil, Columbia, Mexico, and Ecuador. But if these Latin American leaders support crypto due to its potential to bring financial stability to the unbanked, it’s possible that Bitcoin is the wrong crypto horse to back.

Permanent Residence

Meanwhile, Bukele is also offering crypto entrepreneurs immediate permanent residence in El Salvador, noting that El Salvador has no property tax and no capital gains tax on Bitcoin (since it will be legal tender). On June 7, Justin Sun, the founder of the blockchain-based operating system TRON, announced that TRON would become the first crypto organization to establish an office in El Salvador.

“We hope that this decision will be just the beginning in providing a space where some of the leading innovators can reimagine the future of finance, potentially helping billions around the world,” Bukele said via videolink at the Bitcoin 2021 conference in Miami last weekend.