BitcoinEconomy

J.P. Morgan Says Bitcoin Is Too Illiquid to Be Legal Tender. Are They Right?

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Illiquidity could place a “significant limitation" on Bitcoin's use as a medium of exchange in El Salvador, according to analysts from J.P. Morgan.

The banking behemoth's report was released last Thursday and reported on by Bloomberg on Sunday. It references El Salvador's Bitcoin legal tender law, which goes into effect in September.

The report notes that a "large portion of Bitcoin is locked up in illiquid entities" and daily transactions in El Salvador could equal 1% of the total value transferred on-chain last year.

The Bloomberg piece even goes so far as to suggest that this will "put a strain” on the Bitcoin network, offering a quote from William Quigley, the co-founder of Tether (USDt), which states that Bitcoin is "the worst payment system ever invented."

Despite the harsh criticism, the Bitcoin community was quick to note that both the initial report and Bloomberg's presentation of it completely omit any mention of the Lightning Network.

 

The Lightning Network, bitcoiners argue, is not only well-suited to address many of these issues, but its successful trial run in El Zonte, El Salvador (also known as Bitcoin Beach) was the primary catalyst for the Bitcoin legal tender bill, making the omission particularly jarring. 

Lightning helps disqualify comments regarding Bitcoin's lack of suitability for payments, or concerns that volume would "strain" the chain. The Lightning Network, while built on top of the Bitcoin network, does not suffer from the same trade-offs as transacting on-chain. In fact, Lightning is capable of millions of transactions per second at low fees and with near-instant settlement, making it an incredibly powerful tool for payments.

The stronger argument, though far from indisputable, is that Bitcoin lacks the liquidity to be used as a medium of exchange on a large scale. While Lightning greatly increases payment throughput and lowers fees, it still draws liquidity from the Bitcoin blockchain.

According to the report, a "significant and rising fraction" of bitcoin is "held by wallets with light turnover." In Bitcoin vernacular, this means that more and more owners are HODLing rather than spending or selling, believing their bitcoin will gain in value over time. 

This may lower the circulating supply, but as any bitcoiner is aware, a decreasing supply is often considered a feature, not a bug. 

Each bitcoin is divisible into 100,000,00 units known as "satoshis." If HODLing lowers the available supply of bitcoin, it should only serve to raise the value of each satoshi (due to the laws of supply and demand). This would essentially mean that less satoshis would be needed to create the same amount of value in U.S. dollars, making lack of liquidity much less of an issue.

An adjacent concern, left out by J.P. Morgan and Bloomberg, could be the liquidity on the Lightning Network itself. All bitcoin used on Lightning come from the Bitcoin blockchain, but much of the bitcoin on-chain is unlikely to ever be on the Lightning Network.  

In response to this, it could be noted that the amount of bitcoin locked in Lightning channels is growing rapidly to meet demand, up 60% in just one year. Liquidity marketplaces on Lightning provide free market incentives for LSP's (Liquidity Service Providers) to always provide enough liquidity to match demand, since they can make a profit by doing so. When combined with El Salvador's favorable regulations and tax laws regarding Bitcoin, it is difficult to foresee a future in which bitcoin HODLers are not lining up to make a profit lending their bitcoin as liquidity to the network.  

It's also important to note that should the price of Bitcoin fall dramatically or prove to have insufficient liquidity, Salvadorans are always free to pay with U.S. dollars or exchange received bitcoin for U.S. dollars instead. 

The potential downsides for Salvadorans are therefore low, but the potential upsides for the impoverished nation remain high. 

According to The World Bank, 24% of El Salvador's GDP comes from personal remittances from abroad. The Lightning Network in particular will help citizens receive payments from abroad without the exorbitant fees of traditional remittance methods eating up large percentages. This could have a large direct impact on the nations GDP which is currently amongst the lowest in the world. 

El Salvador also has one of the largest unbanked populations in the world with a staggering 70% of the total population not having access to a bank account. Bitcoin and the Lightning Network will provide an alternative means for these people to plug into the global economy in a permission less way, only needing a cell phone to do so. 

Time will tell how the bold move will work out for the Central American nation, but bitcoiners will be waiting with baited breath.

Joshua is a writer and Bitcoin enthusiast. His intellectual interests include geopolitics, philosophy and history. When not writing he enjoys travel and watching basketball.