Bitcoin and Sharia Compliance: How Halal is Bitcoin?

February 28, 2017

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As global bitcoin adoption is rising and bitcoin usage is expanding into markets such as the Middle East, Indonesia, Malaysia and other predominantly Muslim regions, the question of whether the cryptocurrency is compliant with the pillars of Islamic finance becomes more and more topical.

Sharia-compliant Finance

Sharia law requires a currency to have intrinsic value. What that means is that a currency must have a use as opposed to being purely considered valuable because people say it is. The value of a currency must be backed up by an asset or tied to a commodity of actual value, and can also be shown by the difficulty of attaining it. Examples of currencies that are Sharia compliant are the gold Dinar and the silver Dirham. Sharia law also requires a currency to be tangible or to have evidence of existence.

Islam forbids the use of a currency that is tied to debt which is referred to as Riba. Islam also prohibits the charging and profiting from interest paid out on loans; this is because Islam does not believe that money is a commodity, rather it is a means of exchange. With this reasoning in mind, one cannot use money to buy more money. Also, interest is deemed unfair because it automatically favors lender since the lender will get back his money regardless of whether the business endeavor of the debtor was successful or not. This is in itself contrary to another pillar of Sharia compliance.

Sharia-compliant finance also requires the sharing of profit and losses. This means that partners involved in a business endeavor together must share both the profits and losses at a predetermined and pre-agreed upon rate.

Lastly, for a currency to be halal (permissible), it must be deflationary in nature meaning that it is resistant to inflation and has a steady market price. Sharia law also forbids investing into haram (illegal) industries such as pornography, prostitution, alcohol, pork and tobacco.

Bitcoin vs. Fiat Currency

Fiat currency is based on debt and interest, which according to Sharia law technically makes it haram. However, according to Islamic finance rules as long as a financial transaction is concluded in good faith and does not favor one part over the other, dealing in fiat currency is allowed. Financial transactions, however, should be conducted on a spot basis to prevent speculation. Trading currencies for speculative purposes is considered haram.

Bitcoin, on the other hand, is created through the process of mining where the bitcoin mining operation receives a small amount of bitcoin in exchange for processing transactions. This is how new bitcoin come into existence. There are no surprises with supply as the number of bitcoin in circulation in the future can be predetermined. Proof of Work, with electricity and hardware costs, provide the cryptocurrency with intrinsic value.

This process makes bitcoin halal in that it proves that bitcoin has intrinsic value and is not based on debt like fiat currency. The difficulty in mining bitcoin has been compared or linked to the process of mining gold or silver, both of which are considered halal as currency. The other factor that shows the intrinsic value of bitcoin is that its existence is publicly verifiable through the blockchain. Some may argue that Sharia law requires currency to be tangible, which disqualifies bitcoin, but this is discounted by the fact that proof of bitcoin exists in the public blockchain.

Also, fiat currency or at least the physical representation of it, is vulnerable to loss, theft, damage and illegal duplication, while bitcoin can be considered more secure since records in the blockchain are immutable. One more thing to consider is that the physical representation of fiat currency has no real value on its own as it is essentially just a piece of paper.

Cryptocurrencies also include the halal risk sharing policy of Islam to some extent due to their decentralized and crowd-controlled nature while fiat currencies favor the lender. For example, Charles W. Evan studies the Islamic legitimacy of cryptocurrency in the Journal of Islamic Banking and Finance:

“[This paper] concludes that Bitcoin or a similar system might be a more appropriate medium of exchange in Islamic Banking and Finance than riba-backed central bank fiat currency, especially among the unbanked and in small-scale cross-border trade.”

Sharia-compliant Blockchain Companies

Due to the growing demand for Sharia-compliant financial services throughout the world, some entrepreneurs are using blockchain technology to meet these requirements.

In Indonesia, microfinance startup Blossom Finance uses bitcoin to transfer crowdsourced investments to small and medium-sized enterprises in need of capital. The use of bitcoin transactions saves money. In addition to the cost saving factor, Blossom finance is built on the halal risk-sharing factor since it is crowdsourced and profits are shared through investment ratios. Founder and CEO Matthew J. Martin built the business on the concept of no interest, which makes this financial tool Sharia compliant. Blossom finance also does not invest into Haram industries.

Canada-Based GoldMoney was certified Halal during early 2017 for its gold-based financial services. It utilizes blockchain technology to facilitate its financial transactions. While Malaysian company HelloGold also utilizes blockchain technology in its Sharia-compliant gold trading platform to minimise costs and reduce processing delays.

Can Bitcoin and Blockchain-based FinTech be Adopted into Islamic Finance?

In 2014, the Malaysian Fatwa Council, Malaysia’s religious governing council that gives rulings on what is and is not halal, released a statement cautioning against the use of bitcoin as a currency due to its volatile nature, which gives rise to price speculation, and the lack of an authoritative central body. Since Malaysia is a world leader in Islamic finance, this opinion did not help to increase confidence in the use of bitcoin by Muslims around the world. Qatari Muslim Scholar Professor Monzer Kahf voiced a similar opinion. It must be said, however, that these statements followed the unexpected fall of BTC-USD in early 2014. Since then, the price of bitcoin has steadily risen with a decreasing number of large price swings, which has lessened fears regarding its volatility.

Nonetheless, due to bitcoin’s volatile history, which turns holding bitcoin into somewhat of a speculative investment, some could consider the digital currency to be associated with “Gharar.” Gharar refers to speculative transactions and can be translated to risk, hazard or uncertainty, which some scholars believe is haram. Hence, for bitcoin to be halal, bitcoin investors and users must educate themselves about the risks involved before purchasing them and form a plan of action for the possibility of the failure of Bitcoin.

It remains to be seen if and when the leaders in Islamic finance will look into giving bitcoin a lawful status as a halal currency. However, if current trends in steady price growth persist and the creation of oversight bodies into Bitcoin-related fraud cases, one could say it is only a matter of time until bitcoin and cryptocurrencies are accepted and adopted into Sharia-compliant finance.