Legal Tender: Definition, Purpose, and Examples

Key takeaways
* Legal tender is the money a jurisdiction legally requires creditors to accept for debts and financial obligations.
* It is usually the national currency (coins and banknotes) and enables unified exchange, accounting, and monetary policy.
* Legal tender laws limit the widespread use of alternative monies but do not prevent electronic payments that ultimately settle in the national currency.

What is legal tender?

Legal tender is any form of money that a government recognizes by law as acceptable for settling public and private debts, taxes, fines, and contractual obligations. When offered to discharge a debt, legal tender must be accepted. Common examples are central-bank-issued banknotes and government-minted coins.

How legal tender is established

A statute or monetary law typically specifies which instruments are legal tender and which institution is authorized to issue them (for example, a treasury or central bank). Legal tender rules apply within the issuing jurisdiction and can be enforced by courts. Private businesses, however, may refuse certain forms of cash for a sale if no debt has yet been incurred, unless state or local rules prohibit such refusals.

Forms of legal tender

Two broad forms exist:
* Commodity-based money: market-determined commodities (like historically gold or silver) that a government recognizes as acceptable for payment.
* Fiat money: tokens or paper money declared legal tender by the state and not intrinsically valuable; their value derives from legal status and public acceptance.

Checks, debit/credit card payments, and other payment instruments are not legal tender themselves; they are means of transferring or ultimately obtaining legal tender.

Economic functions of legal tender

Legal tender supports the standard functions of money:
* Medium of exchange — reduces transaction costs by providing a commonly accepted payment method.
* Unit of account — prices and contracts are denominated consistently.
* Store of value — preserves purchasing power over time (subject to inflation).
* Standard of deferred payment — accepted for settling future obligations.

Additional effects:
* Legal tender laws facilitate a single-currency environment, reducing costs associated with competing monies.
* They enable central banks and governments to implement monetary policy, control the money supply, and derive seigniorage (the profit from issuing currency).
* In the absence of legal tender rules, phenomena like Gresham’s Law (“bad money drives out good”) can complicate currency circulation and policy.

Cryptocurrencies and legal tender

Most cryptocurrencies are not legal tender because they lack statutory recognition. They can be used for online commerce or private agreements where accepted voluntarily, but they do not replace official currency for legal obligations in most countries.

Notable exceptions:
* El Salvador recognized Bitcoin as legal tender in 2021, making it an official medium of payment alongside the U.S. dollar.
* Venezuela declared the petro a legal tender–type instrument, though it has had limited practical circulation.
* The Marshall Islands introduced a sovereign cryptocurrency as legal tender while the U.S. dollar continues to circulate there.

These experiments highlight legal and practical challenges—such as volatility, acceptance, and enforcement—when nontraditional instruments are elevated to legal tender status.

Key concepts

• Gresham’s Law — “bad money drives out good”: if two forms of money have the same face value but different intrinsic values, the higher-value form tends to be hoarded and the lower-value form circulates.
• Seigniorage — the profit a state earns from issuing currency, equal to the face value of money minus production and distribution costs.

Examples of dollarization

Some countries adopt another country’s currency as legal tender to achieve stability or restore confidence. This practice—often called dollarization when the U.S. dollar is adopted—can eliminate local currency instability but also means losing independent monetary policy.

Summary

Legal tender is the legally recognized medium for settling debts within a jurisdiction. It ensures a common unit of exchange and accounting, supports monetary policy, and discourages competing monies from fragmenting an economy. While technological and monetary innovations like cryptocurrencies challenge traditional money, statutory recognition remains the defining characteristic of legal tender.