Dr. Hylmun Izhar Senior Economist at IRTI, IDB Group
The unprecedented hype of cryptocurrency over the past few years coupled with an increasing prominence of digital economy should not go unnoticed. For sure, the rapid emergence of such phenomenon has considerably altered the landscape of financial transactions and the methods by which the global economy would grow. More importantly, it will potentially change the way economic agents interact in a great deal.
Islamic finance as a growing and niche industry must timely respond to this. Various attempts have been made by different enthusiasts and advocates of Islamic finance to address this topical issue. One central question being constantly discussed is whether investing in cryptocurrency through blockchain technology is Shari’a compliant. To be able to answer this question, the fundamental aspect to dig out is to ensure.
The nature of Cryptocurrency
Why it matters?
Because this will determine whether an investment in cryptocurrency is justified from Sharia point of view. As many advocates of Islamic finance would unanimously agree, the structure by which a contractual agreement is assembled and the type of items being transacted can determine the validity and permissibility of any financial transactions. On this, Sharia through its abundant fiqh interpretations provides guiding principles and a variety of avenues for Sharia-compliant financial activities. With respect to investing in cryptocurrency, there hasn’t been any undivided answer until now, but there are characteristically four opinions:
- OPINION
Cryptocurrency cannot be considered as mal (wealth); it is purely speculative, hence it is not Sharia-compliant
- OPINION
Cryptocurrency is money/currency
- OPINION
Cryptocurrency is an asset
- OPINION
Cryptocurrency is a security
This article, therefore, is an attempt to investigate the possible DNA of cryptocurrency. The word possible’ is used deliberately since the analysis or opinion articulated in t his article; could, in No way be considered as a final statement, let alone a verdict. Rather, it is an endeavor to further stimulate the discussion on this emerging topic. The authoritative bodies to come up with a verdict, in the author’s opinion, would be AAOIFI Shari’a Council and OIC Islamic Fiqh Academy.
Cryptocurrencies: A Brief Introduction
Cryptocurrencies are digital or virtual currencies that are encrypted (secured) using cryptography.
Cryptography refers to the use of encryption techniques to secure and verify the transfer of transactions. Bitcoin represents the first decentralized cryptocurrency, which is powered by a public ledger that records and validates all transactions chronologically, called the Blockchain.
Physical tokens have been and are still being used as means of payment (e.g. gold coins, bank notes). In such setting, a direct exchange of sellers’ goods and buyers’ tokens allows them to achieve an immediate and final settlement. This option is unavailable, however, when the two parties are not present in the same location, necessitating the usage of digital tokens. In a digital currency system, the means of payment is simply a string of bits. This poses a problem, as these strings of bits, as any other digital record, can easily be copied and re-used for payment. Essentially, the digital token can be counterfeited by using it twice which is the so-called double-spending problem.
Cryptocurrencies such as Bitcoin go a step further by removing the need for a trusted third party. Instead, they rely on a decentralized network of (possibly anonymous) validators to maintain and update copies of the ledger. This necessitates that consensus between the validators is maintained about the correct record of transactions so that the users can be sure to receive and keep ownership of balances. But such a consensus ultimately requires that users do not double-spend the currency and that users can trust the validators to accurately update the ledger.
How do cryptocurrencies such as Bitcoin tackle these challenges? Trust in the currency is based on a blockchain, which ensures the distributed verification, updating and storage of the record of transaction histories. This is done by forming a blockchain. A block is a set of transactions that have been conducted between the users of the cryptocurrency. A chain is created from these blocks containing the history of past transactions that allows one to create a ledger where one can publicly verify the amount of balances or currency a user owns. Hence, a blockchain is like a book containing the ledger of all past transactions with a block being a new page recording all the current transactions.
To ensure consensus, validators compete for the right to update the chain with a new block. This competition can take various forms. In Bitcoin, it happens through a process called mining. Miners (i.e. transaction validators) compete to solve a computationally costly problem which is called proof-of-work (PoW). The winner of this mining process has the right to update the chain with a new block. The consensus protocol prescribes then that the longest history will be accepted as the trusted public record.
Why is cryptocurrency deemed speculative; is it a mal (wealth) after all?
The proponents of this view opine that cryptocurrencies, such as Bitcoins are just numbers with digital entries on a cryptic block chain. They have no intrinsic function. Yet, they are just numbers, which are fluctuating in value due to pure speculation. There is no real substance or underlying asset; it is just speculation on the fluctuation of numbers. This can result in cryptocurrencies being non-compliant and a form of maysir and prohibited speculation. This group of proponents liken Bitcoin or any other type of cryptocurrency to solely settling price differences, where the objective is purely the fluctuation of price.
It is important to note that for something to be the subject of a contract, it must be mutaqawwam, meaning that its use is lawful under the Shari’a. Wealth (mal) is an essential building block of Islamic contract law. Mal is defined as tangible things to which human nature inclines. Nazih Hammad, a contemporary jurist in his article in 2007 argues that the entire community of Islamic jurists — Shafi’ites, Malikites, Hanafites and Hanbalites — are of the opinion that there are three elements of wealth; which when present will lead to the conclusion that the obligation has value and from Shari’a perspective, can be exchange for a counter value.
Those three elements are: (1) that the obligation be an intended usufruct, or contain the same; (2) that the usufruct has a monetary value in commercial practice or custom; and (3) that the usufruct be lawful from a Shari’a perspective. Based on this proposition, although there is no issue in crypto currencies being mutaqawwam, it cannot be classified as mal; as inherently it does not have usufruct to be benefited by contracting parties. Its value can only materialize when it is cashed-in using fiat money that backs it up.
Is Cryptocurrency a Currency?
In the literature of classic jurisprudence, what the modern society calls now as money was at that time termed as nuqud or ‘umlah. While nuqud refers to money being widely accepted by a large society, the specific meaning of ‘umlah is a type of currency that is only valid in a certain jurisdiction and may not be widely accepted (see a detailed discussion on this distinction by Hasan Mahmud al Shafii in “al Umlah wa Tarikhuha” on page 197).
The principles of monetary economics theory on money suggest that anything to be considered as money or currency should fulfill the following primary functions — unit of account, medium of exchange, and store of value. While at the outset, different types of cryptocurrency, such as bitcoin, etherum etc may fulfill these functions; such currency lacks of the fourth fundamental customary condition, namely a legal tender issued by government or financial authority such as a central bank. This fourth condition, coincidentally is also put forward by Muhammad Rawas Qal’ah Ji in his “al Mu’amalat al- Maliyah al Mu’ashirah fi Dhau’ al Fiqh wa al-Shar’iyyah on page 23.
Interestingly, traditional jurists state that for anything to qualify as money or currency, it must have a thamaniyyah component that covers dual functions, namely an independent standard of value and unit of account. On this note, it is argued that the current phenomenon of cryptocurrency demonstrates that it does not serve as an independent measure of value. Rather, it is the value of fiat currencies that is being used to determine the value of any form of cryptocurrency. Hence, cryptocurrency does not fulfil a thamaniyyah condition that requires a currency to have an independent reference of value.
Is it an Asset?
An asset maybe divided into fungible (mithliyyat) and non-fungibles (qimiyyat), and into movables and immovable. Asset is owned as either ‘ayn or dayn. ‘Ayn is specific existing thing, considered as a unique object and not merely as a member of a certain category. Dayn is any property, not an ‘ayn, that a debtor owes, either now or in the future; or it can refer to such property only when due in the future.
Some would argue that mithliyyat product possesses a certain degree of thamaniyyah component due to its nature in potentially creating debt (dayn’) when being transacted on a deferred method. This is a unique feature that qimiyyat product does not possess. Consequently, a subtle characterization of mithliyyat comes along, i.e. it cannot be leased-out since the nature of its material is perishable or consumable.
Having described what constitutes an asset, one would immediately notice that a profound feature of an asset is that it should possess an intrinsic value from which people can directly benefit. And cryptocurrency in any of its forms fails to fulfill this condition.
Can It be Considered as a Security?
While no court or government agency has yet opined on whether cryptocurrency is a security. But based on an analysis of a case law applying the definition of “security” under the Securities Act in the United States of America, it appears that cryptocurrency is not asecurity. Let us take an example of Bitcoin. Bitcoin does n ot f all w within the definition of any common type of security. In addition, Bitcoin does not appear to fall within the broad definition of “investment contract”. An sale of B itcoin is not an investment contract because a purchase of Bitcoin is not an investment in a c common enterprise and purchasers should not expect to receive profits from their purchase based on the efforts of the seller. In a nutshell, a cryptocurrency transaction does not reflect an ownership right that can be enforced,
over which future economic benefits may flow to the owner. From fiqh muamalah point of view, a technical detailed analysis in what constitutes financial securities, commercial paper and investment contracts, readers are advised to consult AAOIFI Shari’a Standards no 16 and 17.
A New Era: Tokenisation
So, what is the DNA of a cryptocurrency then? In my view, cryptocurrency is nothing but a token that is created through a process called tokenisation. So, essentially cryptocurrency is none other than a platform. Tokens have no representation of an asset, either physical or intangible, and are by definition confined to the chain in which they exist. I wouldn’t come up with a final statement, let alone a verdict with regard to investing in cryptocurrency as I am not in a position to do so. But I must admit that I failed to find an argument supporting it from Shari’a point of view.
A prime example of this is Bitcoin. When we own Bitcoin, we do not own any claims o n anything that b elongs in the n on digital world. T here is no collateral behind each Bitcoin, we cannot redeem them for an underlying asset, and it does not give us any rights to claim anything against it. Yes, we may be able to use Bitcoin to purchase a cup of coffee, but the merchant accepts your Bitcoins at their own discretion since they have no legal obligation to take our Bitcoin and give us coffee. Bitcoin, therefore, is a soft token as it is confined to its own chain and has no rights outside the block chain.
With the way current cryptocurrencies is structured right now coupled with the exuberance in investing in them, I’m afraid this would worsen the debt creation culture that has overwhelmed the financialisation of our global economy.
Conclusion
As the digital economy era is increasingly embraced by larger societies, what if cryptocurrencies are also gaining its momentum and eventually are a accepted to become means of payment? Could we in the future consider cryptocurrencies as a currency? The answer is: it is possible of course. Nonetheless, its trading will be guided by the rules of Sarf.
What about trading in cryptocurrencies with a main objective of taking advantage of their price differences? As I stated earlier, I wouldn’t be convinced with its permissibility from a fiqh muamalah standpoint. As it is now, the fiqh-compliant twist would perhaps be to find a way to demonstrate that the values of cryptocurrencies represent the values of tangible assets, usufruct or ownership over projects.
