El Salvador’s adoption of bitcoin as legal tender poses challenges for the network, JPMorgan says

A demonstrator holds up a sign against the government's Bitcoin law during a LGBT community Pride parade on June 26, 2021 in San Salvador, El Salvador
A demonstrator holds up a sign against the government’s bitcoin law during a LGBT community Pride parade on June 26, 2021 in El Salvador.

El Salvador’s decision to adopt bitcoin as legal tender poses some systemic risks for the country and the digital asset’s blockchain, according to JPMorgan.

Doubt remains about whether the bitcoin blockchan can practically handle a significant fraction of payment activity were it to become widely used, a team of economists including Steven Palacio, Ben Ramsey, and Joshua Younger wrote in a note published Thursday.

Bitcoin trading volumes commonly exceed between $40-50 billion a day, most of this activity is internalized by major exchanges, they said, adding that on-chain transactions have averaged around $10 billion daily in recent months.

Of that total, only a small fraction represents economic activity or payment made towards a merchant.

A large chunk of bitcoin in circulation is held up in illiquid entities, with more than 90% not being used in any type of transactions for over a year “as well as a significant and rising fraction held by wallets with light turnover,” JPMorgan said.

This means only a very tiny fraction is available for use in everyday transactions.

“Though these aspects do not necessarily challenge the use of bitcoin as a store of value, they are potentially a significant limitation on its potential as a medium of exchange,” the bank’s economists said.

“Daily payment activity in El Salvador would represent ~4% of recent on-chain transaction volume and more than 1% of the total value of tokens which have been transferred between wallets in the past year,” they estimated.

The bank also highlighted a study conducted by El Salvador’s Chamber of Industry and Trade, showing that most participants would convert bitcoin to dollars for current expenses if they receive the cryptocurrency as payment. More than 90% of businesses and individuals said they would prefer usage to be optional, expressing fears of volatility and lack of understanding about how it works.

El Salvador’s bitcoin law is scheduled to come into effect on September 7. President Nayib Bukele hopes this will help the country transition into a developed nation.

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