Cryptocurrencies

How Cryptocurrency Aligns with the Principles of Islamic Banking and Finance

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Islamic finance is a financial system based on Islamic law principles, known as Shariah. As you probably already know, cryptocurrencies are blockchain-based tokens running on decentralized networks with no centralized middlemen.

Cryptocurrencies and the blockchain industry, in general, have grown in popularity over the years, especially since the 2017 and 2022 bull runs. This increased interest has also reached the Islamic Finance sector, with conversations on whether cryptocurrencies are Halal (permissible) or Haram (forbidden). To see whether cryptocurrency is compatible with the tenets of Islamic finance, we must analyze each one separately.

Prohibition of Interest (Riba): Islamic finance prohibits interest-based transactions, as the charging or paying of interest is considered unjust and exploitative. Instead, Islamic finance uses profit and loss sharing arrangements, where the risk and reward are shared between the parties involved.

Cryptocurrency does not involve charging or paying interest, as it is a decentralized currency that operates without the need for traditional banking institutions. Therefore, in this regard, cryptocurrency aligns with the principle of the prohibition of interest in Islamic finance.

Prohibition of Uncertainty (Gharar): Islamic finance also prohibits uncertainty in transactions, which can lead to deception and exploitation. This means that all participants in a financial transaction must be fully informed and comfortable with its terms and conditions before proceeding since this is a fundamental tenet of Islamic finance.

The crypto market is also highly volatile, with large price swings making many tokens unpredictable. The high volatility in the crypto market can create an air of uncertainty among some investors.

Yet the speculative character of the cryptocurrency market is to blame for the uncertainties mentioned above, not cryptocurrency itself. Thus, the Islamic banking concept that forbids ambiguity may be consistent with the usage of cryptocurrencies, provided it is utilized openly and unambiguously.

Prohibition of Gambling (Maysir): Islamic finance also prohibits gambling and speculation, which can lead to excessive risk-taking and uncertainty. Therefore, Islamic finance emphasizes the need for investments based on tangible assets and productive economic activity. When it comes to cryptocurrencies, some people see the high level of speculation being similar to gambling.

However, this is a matter of interpretation, and some cryptocurrency proponents argue that it is a legitimate investment tool that can promote economic growth and development. Therefore, whether cryptocurrency aligns with the principle of the prohibition of gambling in Islamic finance is a matter of debate.

Social and Ethical Responsibility: Islamic finance also emphasizes the importance of social and ethical responsibility and encourages investment in socially responsible projects that positively impact society and the environment.

Cryptocurrency does not inherently promote social and ethical responsibility but can be used for such purposes. For example, some projects have used cryptocurrency to fund social and environmental initiatives. Therefore, cryptocurrency can align with the social and ethical responsibility principle in Islamic finance if used for socially responsible purposes.

Asset-Backed Financing: Islamic finance requires that all financing transactions be asset-backed, meaning they are supported by tangible assets. This ensures that the investment is based on real economic activity and helps to reduce risk. Cryptocurrency is not inherently asset-backed but can be used in asset-backed financing arrangements.  For example, some companies have issued cryptocurrency backed by gold or other tangible assets. Therefore, cryptocurrency can align with the principle of asset-backed financing in Islamic finance if used in asset-backed financing arrangements.

Whether cryptocurrency aligns with the key principles of Islamic finance is a matter of interpretation and debate. While cryptocurrency does not inherently violate key principles, concerns exist around its speculative nature and lack of regulation. However, suppose cryptocurrency is used transparently and responsibly. In that case, it can align with the key principles of Islamic finance and provide a viable alternative to traditional forms of currency.

Cryptocurrencies and Sharia law

Sharia-compliant cryptocurrencies are digital currencies designed and developed to comply with Islamic financial principles, specifically those related to prohibiting usury (riba) and uncertainty (gharar).

There are blockchain networks that are being built with sharia compliance in mind. For example, the Haqq blockchain uses Islamic Coin (ISLM), which was built to address some of the main principles within Islamic Finance. One of those principles is Zakat, which mandates that people should donate a portion of their wealth to people to people who are in need.

10% of any newly minted coins on the network are sent to a decentralized autonomous organization (DAO) called Evergreen DAO that donates the funds to Islamic charities. 

The Haqq chain also doesn't encourage interest, gambling, casinos, etc., projects that negatively impact the community or conflict with Sharia ethics and values. The protocol received a Fatwa in 2022 for its developments toward building a sharia-compliant blockchain network.

The development of sharia-compliant cryptocurrencies involves creating a digital currency backed by tangible assets, such as gold or real estate, which are considered halal (permissible) in Islamic law. The currency must also operate on a transparent and secure blockchain, with transactions being recorded and verified by a network of nodes.

In addition to the technical requirements, sharia-compliant cryptocurrencies must adhere to ethical and moral principles, such as fairness, transparency, and social responsibility. This means ensuring the tokens aren't used for illegal or unethical activities, like money laundering.

To ensure that a cryptocurrency complies with Islamic law standards, a team of specialists in Islamic finance and blockchain technology often works together to achieve this goal. This might include consulting with Islamic experts to ensure shariah compliance and working with authorities to ensure the currency is lawful and complies with all applicable regulations.

Sharia-compliant cryptocurrencies can bring decentralization to financial products in the Muslim world, especially in countries like Malaysia and Indonesia, where there is a high need for financial products that adhere to Islamic law. In addition, these cryptocurrencies can also serve everyday purposes like paying for goods or services.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Anthony Clarke

Anthony Clarke has been involved in the cryptocurrency space as a writer and investor since 2017. Since getting involved in the crypto space, he has been fascinated by the many new applications, technologies and tools in the blockchain ecosystem. Anthony has a strong interest in Blockchain tech, Defi, NFTs, P2E Gaming and many other topics.

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