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The landlocked nation - bordered by Belgium, France and Germany - will allow four cannabis plants to be grown per household.
Public consumption and transportation of weed will still be prohibited; however, consuming or carrying quantities of less than three grams will no longer be classed as a criminal offence, but rather a misdemeanour.
Fines would be reduced to as little as €25 (£21.15/$29.08) for possession of under three grams, down from previous fines between €251 (£212/$291) and €2,500 (£2,114/$2,908).
The government made the historic announcement today (Friday 22 October), citing the ineffectiveness of prohibition and the need to counter illegal supply chains.
Justice minister Sam Tamson said: "We thought we had to act, we have an issue with drugs and cannabis is the drug that is most used and is a large part of the illegal market.
"We want to start by allowing people to grow it at home.
"The idea is that a consumer is not in an illegal situation if he consumes cannabis and that we don't support the whole illegal chain from production to transportation to selling where there is a lot of misery attached.
"We want to do everything we can to get more and more away from the illegal black market."
In keeping with this objective, the government hopes to eventually implement state-regulated production and distribution, with revenues from sales to be invested 'primarily in prevention, education and healthcare in the broad field of addiction'.
In the meantime, people will be allowed to buy seeds online, in shops or import them, but the trade of cannabis will remain prohibited.
The flouting of a UN convention on the control of narcotic drugs - which commits signatories to limit 'exclusively for medical and scientific purposes the production, manufacture, export, import distribution, trade, employment and possession of drugs' - means Luxembourg will become only the third country in the world to make cannabis legal, behind Uruguay and Canada.
It comes after the nation became the first to make public transport free last year.
The country officially introduced Mobilité Gratuite (Free Mobility) on 1 March 2020 and - despite the impact of the pandemic - is pleased with the results thus far.
"The results are positive despite the fact that with confinement and teleworking, everything is not yet running at 100 percent," Dany Frank, spokeswoman Ministry of Mobility and Public Works, told LADbible in May.
"Just before the March 2020 lockdown, the numbers skyrocketed."