IMF Warns El Salvador Against Using Bitcoin as Legal Tender

Given bitcoin’s high price volatility, its use as legal tender entails significant risks to consumer protection, financial integrity and financial stability, the IMF warned El Salvador in the concluding statement of its 2021 Artice IV Mission published on Monday. Bitcoin’s use as legal tender “also gives rise to fiscal contingent liabilities” the IMF added.

The international financing institution, which reviews the fiscal, monetary and external position of its member states annually, recommended “narrowing the scope of the Bitcoin law” and “strengthening the regulation and supervision of the new payment ecosystem”.

The IMF said that El Salvador President Nayib Bukele’s announcement of a $1B “bitcoin-bond” over the weekend had not been discussed in its meetings with the government. But the Article IV concluding statement cautioned that the government’s plans would “require a very careful analysis of implications for, and potential risks to, financial stability”.

El Salvador’s adoption of bitcoin as legal tender

In September, El Salvador adopted bitcoin as its second form of legal tender to go alongside the US dollar. The dollar has been the country’s main form of money since it ditched its old national currency, the colón, back in 2001 after two decades of double-digit inflation.

El Salvador thus became the first country in the world to adopt bitcoin, or any cryptocurrency, as a form of legal tender, creating excitement in the crypto community and drawing ire from critics in equal measure.

With bitcoin now a form of legal tender, economic agents are legally mandated to accept the cryptocurrency as a form of payment for services unless some form of technical impediment exists. The El Salvadorian government introduced a new e-wallet called Chivo which facilitates both US dollar and bitcoin transactions, as well as conversions between the two, and is backed by a $150M government trust fund.

On Saturday, President Bukele announced that El Salvador would build the world’s first “bitcoin city” at the base of the Conchagua volcano, where bitcoin mining would be powered by geothermal energy and there would be no taxes, aside from VAT. The city would initially be funded by the issuance of a $1B bond, the proceeds of which would be invested into bitcoin, a so-called “bitcoin bond”.

IMF recommends stronger regulation, oversight

“Stronger regulation and oversight of the new payment ecosystem (the Chivo e-wallet) should be immediately implemented for consumer protection, anti-money laundering and counter financing of terrorism (AML/CFT), and risk management”, the IMF recommended in its statement on Monday.

“Banking regulation should incorporate prudential safeguards such as conservative capital and liquidity requirements related to Bitcoin exposure”, the group added. “Measures to limit fiscal contingent liabilities, such as winding down the trust fund or withdrawing public subsidies to Chivo, should also be promptly considered”.

Bukele’s announcement of a new bitcoin city backed by bitcoin bonds has not been able to turn the tide for BTC/USD, which continues to trade heavily on Tuesday in the mid-56,000s. For now, support at in the 55,700 area is holding up well, but the cryptocurrency continues to post lower intra-day highs, signaling the likelihood of a downside break. That would open the door to a test of support in the form of the mid-October lows in the 54,000 area and then at the 7 September high just under 53,000.