Bitcoin, the legal tender of El Salvador casts a very long shadow!

When history is being made, it does not feel like history is being made and that’s what exactly happened this weekend.

We knew that one day a sovereign state will take some action which will change the trajectory of crypto adoption. My guess was that it would be the creation of central bank digital currency or CBDC. Old wine in new bottle? yes but the bottle is the magic bottle. China is allegedly working on the digital yuan. US hopefully is also working on a similar instrument. US does have some headwinds though. US does not have a history of a lot of innovation in the public sector and any innovation at all needs sputnik shock.

To my utter surprise, I never thought a small country would adopt bitcoin as a legal tender. Small country but a sovereign nation-state El Salvador. This event has a lot of short-term and long-term repercussions which I would like to cover in this blog.

The two guarantees: Death and Taxes

One of the primary reasons bitcoin adoption is slow is the number of tax events involved. Let’s say I would like to buy a cup of coffee using bitcoins. I transfer $5 to the wallet of the coffee shop. easy, right? Transfer takes up to 10 mins but that should not be a problem if I am drinking coffee there. Same argument can be made for having lunch or dinner in a restaurant.

Issue is that for that $5 for coffee or say $30 for restaurant bill, I have to calculate how much was my cost basis. Let’s say when I acquired the bitcoin, whose fraction I used to pay the bill, was at 50% of today’s price. It means I have to pay either capital gains or regular income tax on $2.5 or $15 respectively.

This sounds ridiculous and it is but US Taxman has no reason to make it less ridiculous. Bitcoin, the official currency of ELS changes it all. A foreign currency’s appreciation against dollar does not generate a tax event. I am sure IRS would take a different position but this event would force IRS to rethink.

Tax residency > Real residency

There were some concerns raised about the use of El Salvador as tax heaven now. I beg to differ. El Salvador would not be tax heaven as long as real business is being conducted there and this would even provide San Salvador a shield. One one hand, San Salvador can ward off money laundering. On the other hand, would encourage businesses to have real operations in ELS. This would increase employment, tourism and in turn GDP.

The Dominance of Almighty Dollar?

Does this event threaten the dominance of USD. May be in the short-term but if US innovates fast, it would not be an issue. Here are the few things US can do:

1. Issue US dollar stable coin as soon as possible.
2. Make crypto to crypto conversation non-taxable as long as it’s first converted to USD coin (I am not calling it USDC as there is already a coin by the same name. I did not mean tax-exempt but non-event so that when the real conversion to fiat happens, tax event gets triggered.

So which country is next?

This guesswork is shooting fish a barrel. If you ask anyone this question, they would look at the map of south and central America and start listing countries there. Paraguay may be the first one. May be Venezuela.