Coercion and coexistence: How El Salvador’s Bitcoin Law may change global finance

“Clearly, the thing that’s transforming is not the technology — the technology is transforming you.” Jeanne Ross, formerly of the MIT Sloan Center for Information Systems Research

If El Salvador’s “Bitcoin Law” was “the shot heard round the world” for Bitcoin, then when the International Monetary Fund (IMF) and the World Bank questioned the legislation, it was the incumbent empire striking back. 

However, if El Salvador can implement its Bitcoin Law despite numerous technical and legal hurdles, it may force changes upon the organizations that oppose it and hasten reforms in how United States tax and commercial laws treat cryptocurrencies. 

The surprise shot heard round the world

After winning approval by a supermajority of its congress, El Salvador enacted its Bitcoin Law and became the first country in the world to adopt Bitcoin as legal tender. The Bitcoin Law passed mere days after El Salvador’s president, Nayib Bukele, first announced his plans to introduce it. The short time between Bukele’s surprise announcement and the passage of the Bitcoin Law prevented opponents from blocking it.

However, in a prescient series of tweets, Avanti Financial Group CEO and Bitcoin advocate Caitlin Long predicted “a big fight” over the Bitcoin Law and warned that “the world is about to pressure it [El Salvador] given what’s at stake.” 

1/ THREAD ABOUT A HISTORIC DAY in #bitcoin: #ElSalvador president publicly announced support for legislation to make #BTC legal tender. *IF* it does become law, it wld have many secondary effects. Steel yourselves bc a big fight on this probably coming thohttps://t.co/BrrNxaLzpZ

— Caitlin Long 🔑 (@CaitlinLong_) June 6, 2021

The IMF’s leverage and lending Pools

Indeed, the day after El Salvador passed the Bitcoin Law, the IMF claimed that the legislation raised “a number of macroeconomic, financial and legal issues that require careful analysis.” The World Bank, which frequently cooperates with the IMF, joined the fray and proclaimed that it had rejected El Salvador’s request for help with implementing its Bitcoin Law because of “environmental and transparency shortcomings.” While these proclamations from powerful Washington, DC-based multinational organizations embody the fight that Long predicted in her tweets, the Bitcoin Law’s forward momentum may hasten reform in how these organizations and laws in the United States address cryptocurrency.

Based on its governing documents, the IMF is more likely to resist the Bitcoin Law by exerting economic pressure than by legally challenging the legislation of a sovereign nation. IMF member nations, including El Salvador, are bound by a code of conduct memorialized in the IMF Articles of Agreement. 

These articles require members to allow their currency to be exchanged for foreign currencies freely and without restriction, keep the IMF informed of changes in financial and monetary policies that will affect fellow members’ economies, and modify their policies to accommodate the needs of the entire membership. The IMF administers a pool of money from which its members can borrow “to help nations abide by the code of conduct” in its Articles of Agreement. In other words, the IMF enforces its articles through access to its lending pool.

Since El Salvador is seeking a $1.3 billion loan from the IMF to revitalize its economy, the IMF could attempt to restrict or withhold this important funding based on the Articles of Agreement. For example, the IMF could argue that it was not adequately informed in advance of the Bitcoin Law. It could also demand that El Salvador limit or modify the Bitcoin Law to accommodate “the needs of the entire membership.” 

However, it appears that concerns over punitive action by the IMF based on the “issues” it raised with the Bitcoin Law may have been overblown. After the IMF voiced its concerns, El Salvador’s finance minister, Alejandro Zelaya, assured the IMF that the country was not abandoning the U.S. dollar as a currency. Zelaya also stated that talks with the IMF were progressing well and claimed that the IMF did not have a problem with the Bitcoin Law. The IMF did not respond to Zelaya’s remarks, and so the jury is still out on what, if any, action the IMF may take in response to the Bitcoin Law.

Assuming El Salvador stands by its Bitcoin Law, it will still need help implementing it. As drafted, the Bitcoin Law only allows 90 days for implementing measures to make Bitcoin legal tender in the country. While El Salvador already has a partnership with the private digital wallet company Strike to build the requisite infrastructure for the Bitcoin Law, the World Bank flatly rejected the country’s request for assistance.

Potential World Bank implications of the Bitcoin Law

Although the World Bank is refusing to assist with the Bitcoin Law, an informative article by Martin Rivers suggests that the legislation may force the World Bank to accept Bitcoin. Specifically, the World Bank’s International Bank for Reconstruction and Development is governed by its founding document, its Articles of Agreement. Section 12 of Article V states that in lieu of accepting a member’s currency in certain cases, the Bank “shall accept […] notes or similar obligations issued by the Government of the member or the depository designated by such member.” 

Thus, the World Bank’s articles would require it to accept a note issued by El Salvador that is backed by its Bitcoin reserves. Section 9 of Article II further states that when the par value of holdings in a member’s currency appreciates, the World Bank must pay the gains back. If the opposite happens, the member must contribute additional currency to maintain the par value of its holdings. Consequently, if Bitcoin is deemed a local currency of El Salvador, the World Bank could be accumulating Bitcoin or paying El Salvador Bitcoin gains depending on cryptocurrency’s price action.

The Central American Bank for Economic Integration expresses support

Regardless of the World Bank’s position on the Bitcoin Law, other banking organizations focused on Central America are offering to help implement it. For example, Dante Mossi, executive president of the Central American Bank for Economic Integration (CABEI), stated that the bank will give El Salvador technical assistance in implementing the Bitcoin Law.

The CABEI has 15 member countries and seeks to “promote the economic integration and the balanced economic and social development of the Central American region.” In voicing his support for the Bitcoin Law, Mossi noted that it would lower the cost of remittances for relatives of Salvadoran nationals living abroad. While Mossi stated that he is “very optimistic” about El Salvador making Bitcoin legal tender, he is also asking El Salvador’s government to develop regulations to prevent “bad actors” from taking advantage of Bitcoin’s pseudonymous features.

Hastened tax and commercial law reform in the U.S.

The Bitcoin Law could also force needed reform in how U.S. tax and commercial laws treat cryptocurrencies. In March 2014, the Internal Revenue Service issued a notice characterizing cryptocurrencies as property. In issuing this notice, the IRS observed that although a digital currency can operate like a “real” currency, “It does not have legal tender status in any jurisdiction.” 

Now that Bitcoin is legal tender in El Salvador, the IRS may be forced to reexamine the principles it articulated for treating Bitcoin as property for tax purposes. If the IRS were to treat Bitcoin as a traditional currency, this would require any trading or investment gains on the asset to be taxed at ordinary income tax rates instead of more favorable capital gains tax rates. However, decentralized cryptocurrencies like Bitcoin do not fit within the Department of Treasury regulations that define currency as coin or paper issued by a country.

Current tax regulations and currency definitions are a poor fit for Bitcoin because they preceded the advent of blockchain technology. However, U.S. taxpayers with family or business in El Salvador and other countries that adopt Bitcoin as legal tender will need better clarity regarding their tax obligations. 

Instead of forcing an outdated framework onto Bitcoin, lawmakers and regulators should draft new rules that are tailored to cryptocurrencies and do not impose overwhelmingly complicated reporting burdens on a growing number of Bitcoin users. The creation of a tax safe harbor for certain de minimis cryptocurrency transactions, such as the one proposed in The Virtual Currency Tax Fairness Act of 2020 introduced in the House by Rep. Suzan DelBene, could be a good start.

In fact, tax law already provides a safe harbor for small transactions in foreign currencies. Specifically, 26 U.S.C. § 988(e) states that gains from “personal” transactions under $200 involving foreign currencies are exempt from taxation. With El Salvador’s adoption of Bitcoin as legal tender, some U.S. citizens might argue that Bitcoin is a foreign currency and that gains from Bitcoin transactions under $200 are not taxable. 

However, this exemption only applies to “personal” transactions and not those undertaken for trading and investment purposes. Thus, absent tax reform, it appears that all transactions in Bitcoin will continue to be taxable events. This reality will impose complicated reporting burdens on U.S. taxpayers who send regular Bitcoin micropayments to their families in El Salvador.

While politics may indefinitely delay meaningful tax reform, the legal experts who write private commercial law in the United States are already moving to accommodate cryptocurrencies. The Uniform Commercial Code (UCC) harmonizes the laws of commercial transactions and plays a crucial role in bringing greater certainty to business dealings. Currently, it is debatable whether Bitcoin’s adoption as legal tender by El Salvador makes it “money” under Sections 1-201(a)(24) and 9-312(b)(3) of the UCC.

This uncertainty makes it difficult to incorporate Bitcoin into secured transactions under the UCC. However, the Uniform Law Commission has drafted proposed changes to the UCC that specifically address “intangible money” like Bitcoin. These proposed changes clarify that security interests in “intangible money” can be perfected solely by establishing “control” over the asset.

Bitcoin’s adoption forces change

Bitcoin is now recognized as legal tender by a sovereign nation but is struggling to coexist with powerful financial organizations and laws that were designed for an economy that predated blockchain technology. It appears that El Salvador is moving forward with the implementation of its Bitcoin Law despite skepticism and resistance. If El Salvador implements the Bitcoin Law and other nations follow its example, Bitcoin may change the organizations that are resisting its adoption and hasten needed legal and financial reforms for handling cryptocurrencies.

This article is for general information purposes and is not intended to be and should not be taken as legal advice.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph or of Nelson Mullins Riley & Scarborough.