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05 November 2018

Reconciling cryptocurrency in Islamic finance

Dr. Arindam Banerjee Associate Professor, Finance, Amity University, Dubai Campus argues that crypto is not suited as a means of exchange in Islamic banking and financial institutions

Cryptocurrencies also known as virtual or digital currencies digitally represent a value that can be digitally traded.  They function as a medium of exchange, a unit of account and/or a store of value, but does not have legal tender status in any jurisdiction. It is not issued or guaranteed by any government, and functions only by agreement within the limited community of users. Cryptocurrencies are different from fiat currency or “real currency”, which is the physical money that makes up any country’s legal tender, and they are also different from e-money, which is a digital representation of fiat currency.

Over the last few years, the market capitalisation of cryptocurrencies, popularly known as cryptos, have reached a near $400 billion with over 1500 currencies been created. Among them, bitcoin has been the most popular and preferred one with a present market capitalisation of over $150 billion. In the light of such growing popularity, it is worth exploring whether cryptos such as bitcoin or a similar system have the ability to create an alternative medium of exchange in Islamic finance as compared to traditional Riba-backed central bank fiat currency, especially among the unbanked and in small-scale cross-border trade.

It is widely argued that certain practises of Islamic banking are ‘questionably asymmetrical’ and ‘in consonance with the letter rather than the spirit’ of Islamic traditions. Disagreement continues among advocates and observers pertaining to the distinction between what is permitted or required (Halal) and what is forbidden (Haram) under different interpretations of Islamic Law (Shari'ah), but Islamic finance scholars universally agree that all transactions should involve the transfer of real goods and services.

Currently, there are divergent opinions regarding the Islamic understanding of bitcoin among Shari'ah scholars. A section of Shari'ah scholars believe that bitcoin is purely speculative and a non-Shari'ah compliant investment and thus does not quality as Māl (wealth) while others believe that it is a digital asset and not money. There are also some who completely differ and opine that bitcoin is currency.

Desirability and storability are two prerequisites for anything to be qualify as Māl. Scholars who propound that bitcoin is a digital asset and not money looks into the economic demand for bitcoin. With the upsurge in demand and value of bitcoin throughout 2017, with the value of one bitcoin surpassing the value of a troy ounce of gold clearly indicated the desirability of bitcoins. With respect to storability, bitcoins are encoded within the Blockchain and are entries on a public ledger. The ownership of bitcoins is reflected by their owner’s address being credited with a balance. Thus, bitcoins pass the criterion of storability as they are stored on the shared ledger. Also, considering that bitcoins are merely digits, there is no evidence that indicates them being unlawful. Hence, bitcoins have Taqawwum (anything used as Māl).

Additionally, bitcoin to be considered as Māl, needs to have economic value that can be retrieved. Keeping this in mind, bitcoin qualifies as a digital asset. Further, with advancements in technological developments, it is not essential for something to be like a classical asset; the very nature of bitcoin and cryptocurrencies lies in its innovation. Thus, bitcoins are means of merely settling of prices and speculation and that they are a digital representation of a value that can be transferred and used. Thus, bitcoins are deemed to be digital assets and not money and can be considered as a currency.   

However, scholars who advocate that bitcoins are not Māl, argue that they are just numbers with digital entries on a cryptic blockchain lacking both intrinsic function and utility. On the other hand, there are digital assets and real assets (‘Urūḍ) in existence that serve a purpose and function. They have some intrinsic utility and benefit. bitcoins 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 argument results in cryptocurrencies being Shari'ah non-compliant from the standpoint of maysir (speculation).

However, to understand the reality of bitcoin, one needs to observe the benefits and uses to see how different it is from other financial assets such as derivatives; bitcoins can be used and are used to trade. The bitcoins in themselves are the assets, whereas, derivatives and financial instruments are nothing in themselves but representations of the price fluctuations of underlying assets they represent. Thus, the difference between the two is: The value of bitcoin is in themselves and not in an underlying asset, whereas, derivatives do not hold any value, instead, the value represents an underlying asset and the derivative contract and instrument is purely a price reflecting the price of the underlying asset.

Now, let us focus on those who consider bitcoins as money and a currency. As per Shari'ah interpretations, something to be considered as money and a currency needs to have Thamaniyyah, implying that they possess an independent standard of value and a unit of account.

Currently, bitcoins do not possess an independent measure of value. Rather, the values of fiat currencies such as the US dollar are used to determine the value of bitcoin. Thamaniyyah demands that the currency itself should provide a clear reference of value, but bitcoin falls short of being an independent reference of value. Additionally, the instability and instability in bitcoin contradicts the entire purpose of money being a stabiliser and balance for our worldly life. Therefore, with the volatility and uncertainty, bitcoin loses its primary role and function since something unstable cannot bring stability to others.

So, those who propound that bitcoin is a digital asset and not money but is currency can support their argument that bitcoin can still serve as a medium of exchange in isolated transactions; also, something which does not have Thamaniyyah can still be traded and used as a medium of exchange in a transaction. bitcoin will then be regarded as Thaman (price) in that particular transaction.

However, those who believe that bitcoin in not Māl and is purely speculative and non-Shari'ah compliant believe it is not a real asset or Māl and cannot be used as a medium of exchange whatsoever, let alone as an investment.

Cryptocurrencies are not fiat currency as fiat currencies are part of a centralised system. Besides, upon being withdrawn, fiat currencies serve as collectible items due to their coinage. On the other hand, cryptocurrencies are part of a decentralised system. Upon withdrawal or decline, it is questionable whether they will serve as collectibles or merely be strands of random digits? However, cryptocurrencies resemble fiat currencies from the aspect that in and of itself, it has no intrinsic value, rather, something extrinsic is giving it value.

 n the case of fiat currencies, it is the government backing that is giving value, whereas, cryptocurrencies draw their value from the trust of people, supply and demand and from the overall concept. Finally, cryptocurrencies are not electronic money. Electronic money is part of the centralised system and a digital representation of a fiat currency.

Considering all of the above, it is difficult to argue at the current stage that bitcoin is a currency proper in Islamic law and could have the potential to create an alternative medium of exchange in Islamic finance as compared to traditional Riba-backed central bank fiat currency.

The views expressed in this article are solely those of the author and do not represent the institution that he represents.




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