Is Islamic finance ready for cryptocurrencies?

The Shariah compliance debate of cryptocurrencies is neither new nor resolved but it has certainly gained extra mileage the past few months as the stunning (and erratic) rise of cryptocurrencies persists. Our sister publication, IFN, in August 2017 explored the subject matter extensively, however, drastic developments have unfolded since then, including the issuance of Fatwa against and for cryptocurrencies by prominent scholars. IFN Fintech is following up by taking a closer look at the contrarian judgements being passed and how regulators of key Islamic financial markets are reacting to digital currencies.

Two sides to every story
In recent months, more Shariah scholars have come forward with their opinions on the permissibility of bitcoin and cryptocurrencies, including the Grand Mufti of Egypt, Shawki Ibrahim Abdel-Karim Allam, and Shaikh Haitham Al-Haddad, a respected jurist who serves as a judge for the Islamic Council of Europe and sits on the UK’s Islamic Shariah Council. Both have issued Fatwa early 2018 declaring bitcoin as Haram.

The common argument against the permissibility of bitcoin essentially revolves around its volatility and the impossibility of implementing an effective and efficient supervisory mechanism to safeguard the economy and public at large from decentralized digital currencies.

The unpredictability and sensitivity of bitcoin prices to market sentiments is a big issue: it is viewed as inherently risky, driven by speculation and susceptible to abuse – these go against the very foundation of Shariah finance, scholars argue. And while many agree, many also see flaws in the rationale.

“[Shaikh Haitham] uses the argument that bitcoin has grown exponentially in price, but as we know, this is a function of its evolutionary stage. It is in the process of being understood and adopted by merchants, by the people, even by governments. It has not been fully mined yet,” responded Harris Irfan, the chairman of UK Islamic Fintech Panel and a partner at Gateway Islamic Advisory, in an open letter to the Shaikh. “It’s like the internet in the early 1990s. Of course, its price is growing rapidly, of course it’s volatile. Just because a government adopts a currency doesn’t mean the government is in control of all macroeconomic variables that affect its price. It only controls the price of fiat money by manipulating it by printing more!

“If what he is actually implying is that bitcoin is not ready to be a currency yet because the price is not yet stable, then fair enough, he may have a point. But unless we pass through this transitory phase, we will never get to the stability phase and the benefits will never be realized. It’s like saying we should never invest in a start-up company,” explained Harris.

Nida Khan, a doctoral candidate in blockchain and data analytics with the University of Luxembourg and the developer of a blockchain-based decentralized app for Zakat, is with the scholars in declaring bitcoin as impermissible.

“Spoofing is rampant in bitcoin and there is a Hadith in [Islam] that we are not to artificially raise prices against one another, which is exactly what is happening in bitcoin by using bid walls,” she noted.
She did however add: “Maybe in [the] future, it becomes regulated and then the scenario would change, but right now, it is not permissible… The issue does not lie with bitcoin, but the way it is being used presently with speculation and as long as this continues, it is impermissible for any Muslim.”

Currency or speculative instrument?
Nida brings up an important point: the problem is not with the cryptocurrency, but with the intention of the user – are cryptocurrencies being used as mediums of exchange or as speculative instruments?

“In our view, cryptocurrencies do not meet the basic two requisites of a currency: an effective mean of exchange and an effective store of value. First, cryptocurrencies are still not widely accepted as payment instruments, although the list of companies accepting them have increased over the past few years. Second, the volatility that we have observed over the past 12 months in the valuation of some cryptocurrencies and their market cap is the most meaningful evidence that they fail the test of value storage,” opined Mohamed Damak, a credit analyst and the global head of Islamic finance at S&P Global Ratings. In the first 10 days of February 2018, the market cap of cryptocurrencies dropped by around US$185 billion from the 28th January 2018.

In many ways, cryptographic-based currencies fit the mold of Sunnah money: they hold intrinsic value from the energy used to produce them, they are not based on interest, they are often inflation-proof and blockchain transactions are virtually tamper-proof and transparent.

Yet, some, including the religious councils in Malaysia and Indonesia, do not see bitcoin as a suitable a medium of exchange as it is subject to a high chance of manipulation in the open market. It is, however, important to note that neither the Fatwa issued by the Malaysian or Indonesian religious councils dismissed cryptocurrencies as Haram per se; rather the legal uncertainties shrouding virtual currencies and their highly volatile nature make such transactions undesirable and against Muslim sensitivities.

Hypothetically speaking, if these elements of volatility and uncertainties were to be removed — and some argue that they would be with time as regulators become more familiar with bitcoin and the market continues to mature – bitcoin could potentially meet Shariah requirements.

Compliant currency
Technically, if a digital currency has a value, which can be independently verifiable and has an ownership linkage between the digital currency and that commodity/asset, then it could be deemed Shariah compliant. Backing tokens with a real asset could be a solution, although some say a physical commodity may not actually be necessary.

“The Ulama today consider [bitcoin] as Haram because it is Gharar (uncertain). But in my humble opinion, they misunderstand the difference between uncertainty and risk,” Dr Daud Bakar, the chairman of Amanie Group who also chairs the Shariah advisory councils of Bank Negara Malaysia (BNM) and Securities Commission Malaysia (SC), has publicly stated, adding that risk is part and parcel of life. Currencies currently being used worldwide, according to the Malaysian scholar, are no longer based on gold or silver, but on trust, similar to digital currencies.

There are several blockchain-based currencies which could meet the Shariah requirements of what constitutes as money. GOLDX, the Ethereum ERC20 gold-backed token issued by HelloGold, is a prime example. The digital currency has recently been certified as Shariah compliant by Amanie Advisors (See report page 13), demonstrating there is room for Halal virtual currencies.

Regulatory reaction
Regulators are taking a cautious approach. So far, none has taken an official stand on the Shariah compliance of cryptocurrencies, although it is understood that authorities of a few Islamic financial markets are studying the issue. The global cryptocurrency conversation is currently being dominated by the legitimacy of the instrument.

In the last two months alone, Islamic finance captains Malaysia, Indonesia, Abu Dhabi and Iran either issued caution against such instruments or revealed they are working on regulating digital currencies and cryptocurrency-related activities.

In Malaysia, both the SC and BNM do not recognize cryptocurrencies as a legal tender and have warned that conducting initial coin offering (ICO) schemes which involve activities subject to laws administered by the SC and BNM without proper authorization is an offense.

“Issuers of ICOs should be mindful that the launching of an ICO, the offering of digital tokens in exchange for digital currency or any form of payment and incidental activities thereof, may trigger regulatory requirements under securities laws,” the SC, which is looking at creating a framework for cryptocurrencies, said.

In addition, no person is permitted to carry out any regulated activities such as fundraising, fund management and dealing in capital market products without obtaining necessary approval or authorization from the SC.

ICO operators are also prohibited from undertaking regulated activities such as deposit taking and banking business, foreign exchange administration activities and remittances, without the authorization from BNM. BNM in December issued draft regulations for cryptocurrency exchanges that operate in Malaysia.

Indonesia, which has banned cryptocurrency payments, last month sternly warned the public against owning, selling and trading virtual money.

“The Ministry of Finance continues to work closely with other financial authorities to thoroughly examine the development of the use of this virtual currency and to take the measures necessary to mitigate the risks of circulation and the use of virtual currency in order to safeguard public interest and maintain the credibility and stability of the financial system,” Nufransa Wira Sakti, the ministry’s spokesperson, said.

The Financial Services Regulatory Authority of Abu Dhabi Global Market on the other hand is reviewing and considering developing a “robust, risk-appropriate regulatory framework to regulate and supervise activities of virtual currency exchanges and intermediaries”. This follows its ICO guidance released in October.

Cryptocurrencies are a divisive issue. Advocates view digital currencies as revolutionary, critics see them as adversely disruptive; from how to regulate it, to its compliance with the Shariah, the global phenomenon elicits passionate arguments from both sides of the divide. The conversation must go on, and more importantly, it must be followed by action.

“Whether cryptocurrencies take off or not, we believe that banks’ role in the payment business might change materially in the next decade,” said S&P. “In some markets, we think that a framework backed by authorities could boost the general public adoption and the new currency might be used as a means of exchange or a currency instead of an investment asset class or a speculative instrument.”

Bitcoin (and most cryptocurrencies in general) might still be too young to fulfil the currency criteria of the Shariah, but with time and perhaps policy-tinkering (and deeper understanding of the instrument and underlying technology by scholars), who is to say that it won’t be accepted as an effective Shariah compliant means of exchange and an effective store of value in the near future?


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