Experts think El Salvador's move to legalise Bitcoin could strain the blockchain

El Salvador’s declaration of Bitcoin as legal tender could create challenges for both the country and the cryptocurrency, according to a team from JPMorgan Chase & Co.

Bitcoin trading volumes commonly exceed $40 billion to $50 billion per day, but most of that is internalized by major exchanges, said a group from JPMorgan including Steve Palacio, Joshua Younger and Veronica Mejia Bustamante, in a report Thursday. A large portion of Bitcoin is locked up in illiquid entities, with more than 90% not changing hands in more than a year -- with a “significant and rising fraction held by wallets with light turnover,” they added.

“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,” the report said, with the illiquidity and nature of the volume “potentially a significant limitation on its potential as a medium of exchange.”

El Salvador President Nayib Bukele’s initiative to make Bitcoin legal tender in the country has set off a raft of debate about whether it’s beneficial and what the ramifications could be. The 39-year-old Bukele has said that Bitcoin will help counter the country’s low banking penetration rate and cut the cost of sending remittances. But the International Monetary Fund – which is in discussions with El Salvador about its credit program now – is among those who have questioned that rationale.

Even many proponents of Bitcoin say that, while there’s an argument it’s a good store of value, its utility as a payments mechanism is limited.

“Bitcoin is the worst payment system ever invented. It’s terrible,” said William Quigley, the co-founder of stablecoin Tether and a pioneer of multiple aspects of the cryptocurrency space, in a recent video interview. “Almost any token is better than Bitcoin as a payment system.”

Other challenges JPMorgan sees for El Salvador’s adoption of Bitcoin as legal tender include:

• Recent surveys suggest widespread skepticism and hesitance of Bitcoin as a medium of exchange
• Bitcoin’s high volatility poses a particularly large challenge in a bimonetary system alongside official dollarization
• A persistent imbalance of demand for Bitcoin/U.S. dollar conversions on the government platform could “cannibalize onshore dollar liquidity” and eventually introduce fiscal and balance of payments risk