The addition of Bitcoin (BTC) and other crypto-currencies/digital commodities, as virtual currencies with a bidirectional flow, has impacted and will continue to impact the world of finance and finance technology greatly. The BTC protocol and the platforms arising from it (e.g. Ethereum & Litecoin) enable the creation of alternative payment systems with enhanced privacy, as well as applying the decentralised consensus engine concept of BitTorrent to finance.
The growth of emerging economies offers an opportunity to grow Bitcoin adoption, applying especially to developing countries with significant Muslims populations. Notably, Bangladesh, Indonesia, India and Pakistan are countries with significant populations which have large expatriate populations distributed around EMEA (Europe, Middle East & Africa) markets.
Islamic Finance & BTC
Islamic finance refers to the means by which corporations operating in markets, including banks and other lending institutions, raise capital in accordance with Sharia – the Islamic law. They can be considered a form of socially responsible investment. It also offers a way of disrupting payment transfer infrastructure used for remittances by the Islamic diaspora.
Compared with fiat currency, BTC can be considered a digital commodity. Treating BTC as a commodity means that renting of the commodity aligns it with Sharia principles, instead of lending based on interest – the conventional method.
Central to Islamic banking and finance is an understanding of the importance of risk sharing as part of raising capital and the avoidance of riba (usury) and gharar (risk or uncertainty). Islamic law views lending with interest payments as a relationship favouring the lender, who charges interest at the borrower’s expense.
Because Sharia views money as a metric for value, rather than an asset, it requires that individuals should not receive income from money alone (e.g. interest). Deemed riba (literally an increase or growth), such practice is proscribed under Islamic law (haram, meaning prohibited) as it is considered usurious and exploitative.
Equally important is gharar. Defined as risk or uncertainty, in a financial context it refers to the sale of objects whose existence is uncertain. Examples of gharar would be certain types of insurance (i.e. purchase of premiums to insure against something that may or may not occur or derivatives used to hedge against possible outcomes).
The Principles of Islamic Finance
Islamic Finance is designed as a system of ethically correct financial transactions and agents, governed by the Sharia Law. Islamic Finance Requirements (IFRs), also termed IFR-compliant/Sharia-compliant financial systems, are not necessarily Islamic, for secularists uncomfortable with religious terminology.
The five principles determining IFR-compliant finance are:
- Interest prohibition (IP). Interest on debt must neither be asked and received nor promised and paid.
- No misleading/misrepresentation. Agents should not mislead their trade partners. Trade partners are entitled to know what they buy. Further trade partners must be able to take their own decisions in freedom.
- True entity requirement. Transactions against money must deal with existing goods and services (true entities).
- Gambling prohibition (GP). Gambling is forbidden.
- Mandatory donation. Agents must donate a reasonable fraction of their income to those in need.
Going in-depth, we need to ask “What is money in Islam?”. Answering, we refer to the works of Imran Hosein, specifically his book “The Gold Dinar and Silver Dirham.” Hosein identifies six commodities used as money in the Prophet Muhammad’s community.
Gold and silver are explicitly mentioned, but when scarce, Muslims would use dates, wheat, barley and salt – food products with intrinsic value (i.e. calorie and barter value).Furthermore, there are records of Muhammad applying the rules associated with money to these commodities, but not to other goods (i.e. livestock), which were not used as money.
Muslims accepted some foreign currency while rejecting others in later generations. Other commodities were used in regions where the original six commodities were uncommon or unavailable. Rice in Indonesia replaced dates, barley and wheat for example, while sugar was used in Cuba. Hosein identifies six traits common to all of these that amount to an Islamic definition of money:
- Money is either precious metal(s) or food(s).
- Money is abundant and freely available.
- Money is durable and does not spoil or corrode.
- Money has intrinsic value.
- Money exists in creation and is made valuable by God.
- Money functions as a medium exchange.
Hosein qualified and explained the first requirement:
Some scholars of Islam argue that mankind is free to use anything, even a grain of sand, as money. They then go on to declare that there is no prohibition to printing paper for use as money and then assigning any value to the paper. Our response is that only Allah Most High is al-Razzaq, the Creator of wealth. Whoever attempts to assume the divine prerogative by creating wealth out of paper, or arbitrarily assigning to grains of sand a value quite different from their natural value, would be guilty of Shirk (Idolatry).
His objection to sand and paper is their lack of intrinsic value. When describing intrinsic value, natural value, and God-given value (interchangeable terms), Hosein’s test is the value is determined by supply and demand, not artificially assigned by central planners.If a commodity is neither metal nor food but fulfils the other five traits listed, it can effectively function as money in a secular context.
Because BTC is a digital commodity, the following qualities potentially render it Sharia-compliant:
- A fixed supply of 21 million BTC – being relatively abundant and available at this stage of market development.
- A virtual currency highly resistant to market shocks, durable as gold or silver, it is more durable than wheat, barley or dates.
- Bitcoin is accepted as a medium of exchange by major firms (e.g. Dell and Expedia).
Does BTC have intrinsic value? Critics ask what commodity backs Bitcoin, but the answer is thatit is only valuable because people value it – much like fiat currencies. What is gold backed by? The answer is the same. It’s only valuable because people value it. But that isn’t a complete answer.
Some people value BTC for the potential anonymity, others because it can be transferred over the internet without fees, others for the peace of mind that their account cannot be frozen by a central authority. However, like gold, it has applications beyond finance, having inherent value within cyberspace due to the applications of the Bitcoin protocol (i.e. smart contracts & private transactions).
BTC is still a volatile currency, increasing adoption and trade will lead to a reduction in overall volatility. Framing it and presenting it as a digital commodity suited for investment within the framework of Sharia creates opportunities for greater wealth, as well as serving to grow the adoption of Bitcoin in the markets that matter – emerging economies.
This is an abridged version of “Bitcoin as an Islamic Finance Investment Instrument” on LinkedIn Pulse“.