Here’s what making bitcoin legal tender actually means

Ever since El Salvador’s president Nayib Bukele shocked the world by declaring last June that bitcoin would be legal tender in his country, many of the digital currency’s advocates have been on the edge of their seats with anticipation for which countries might be next.

During the past several months, bitcoiners have cycled through thinly-sourced and ultimately false rumors that Brazil, Honduras and Mexico were poised to follow in El Salvador’s footsteps. These misunderstandings appear to stem from real efforts in each country to regulate crypto.   

Then came the spectacle of Bitcoin 2022 in Miami, a massive gathering of enthusiasts in early April that added even more confusion. A presentation hosted by ex-Blockstream chief strategy officer Samson Mow led many to think that Madeira, an autonomous region in Portugal made up of islands off the northwest coast of Africa, had made bitcoin legal tender. As it turns out, it did not. 

Another jurisdiction, a special economic zone called Próspera on a Honduran island, announced around the same time that it would “effectively” make Bitcoin legal tender — but only after Twitter posts circulated a fake quote from president Xiomara Castro in the weeks leading up to the conference indicating that the entire country of Honduras would be doing so. 

And finally, on April 27, the Central African Republic became the second nation to declare bitcoin legal tender.

But the focus on the question of which countries will follow El Salvador has overshadowed more fundamental ones. What does it even mean for a country to declare a cryptocurrency legal tender? And what practical difference does it make in the day-to-day lives of the people who live there? 

Legal tender, El Salvador-style

At a high level, “legal tender” has a simple definition: money that people living in a given jurisdiction can use to pay outstanding debts and taxes.

El Salvador, however, has taken things a few steps further. Its bitcoin law allows people to not only pay taxes or debts with the cryptocurrency, but requires most businesses to accept it as a payment method. It also stipulated that citizens would not have to pay capital gains taxes on cryptocurrency trades. And the day the law went into effect, the government also released a digital wallet called Chivo, which was supposed to incentivize adoption by paying out a $30 bitcoin bonus to anyone who signed up. 

The narrative that other countries are preparing to follow El Salvador’s lead often misses this part. El Salvador did a lot more than simply declare bitcoin legal tender — it also made a deliberate legislative effort to kickstart adoption.

Perhaps this is why so many people tend to think the term legal tender automatically signals a requirement that merchants accept it.

The term "legal tender" is often mistakenly understood as a form of money that is acceptable for all payments, according to Rohan Grey, assistant professor of law at Willamette University. 

“You do not have to accept legal tender in the initial commercial exchange,” Grey says. “You only have to accept it once it's been created as a debt, and that's actually a very big difference.” 

Tax Matters

Outside of El Salvador, many Bitcoiners also seem to mistakenly think that legal tender status not only makes it possible to pay taxes with bitcoin but also eliminates capital gains taxes. 

Jerry Brito, executive director at Coin Center, encountered this misconception recently after he accidentally started a Twitter dustup by asking a simple question: “Why do people think making bitcoin legal tender will do anything?” 

He was compelled to ask this after seeing two people announce their US Senate candidacies with the platform of making bitcoin legal tender. “What I got back was a deluge of confusion, illogic, and hostility that I was not anticipating,” Brito wrote in a blog post about the incident.

Many people responded that making crypto legal tender would also eliminate capital gains taxes related to crypto — a premise he called “some kind of meme legend." 

“I think that some people think that legal tender means that something would not be subject to capital gains taxation,” Brito told The Block in a recent interview. “That is not true — those are two separate things. If you want bitcoin to not be subject to capital gains taxation, you would have to amend the tax code.” 

Where might this “meme legend” come from? Brito says he’s not completely sure but has some ideas.

“From talking to folks on social media, I get the sense some people think that because the dollar is legal tender, and one doesn't pay capital gains on exchanges of dollars for goods and services, then it means legal tender status exempts a currency from capital gains,” Brito said in a subsequent email exchange. “But of course, the reason one doesn't pay capital gains on dollar transactions is that taxes are denominated in dollars, so there's never any gain or loss.”

Legal tender status doesn’t guarantee adoption

One of the most visible parts of El Salvador’s push to drive bitcoin adoption is the apparent availability of the currency as a payment method at major stores around the country. Crypto enthusiasts visiting El Salvador have marveled at how they can buy McDonald’s hamburgers or Starbucks coffees in bitcoin using their Lightning Network wallets — something that hasn’t been so easy at a majority of US retailers.

But a recently-published academic research paper paints a different picture. The working paper, published by the National Bureau of Economic Research (NBER), surveyed 1,800 households in El Salvador. It concluded that even though the government has encouraged adoption, everyday bitcoin usage among Salvadoran residents remains low.

According to the NBER paper, only about 5% of respondents used the government-provided Chivo wallet to pay taxes.

In part, the overall trend appears due to the public’s mistrust and a broad lack of understanding about bitcoin. However, researchers also found that only a small number of firms in El Salvador surveyed are truly accepting bitcoin as a payment method, despite the law requiring them to do so. 

“Crypto as legal tender, and regulations that have followed, do not imply that crypto would be adopted widely by the population despite this being the intention of the laws,” says David Argente, an economist at Penn State University and co-author of the NBER paper. 

“In fact, our paper shows that declaring a cryptocurrency as legal tender is not enough to make bitcoin an acceptable medium of exchange.”