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How Are Bitcoin System of Transactions Qualified From An Islamic Finance Perspective?

Internet transactions heavily rely on financial institutions acting as trusted third parties to process electronic payments. While this system works for most transactions, it has inherent weaknesses due to its reliance on trust. Completely non-reversible transactions are not feasible, as financial institutions must mediate disputes. Mediation increases transaction costs, limits minimum transaction sizes, and hampers small casual transactions. In Islam, e-business concepts such as e-commerce and e-banking are generally accepted as compliant with Shariah, as anything is considered halal unless explicitly prohibited. How about trusting in Bitcoin?

The need for trust spreads due to the possibility of reversals, leading merchants to request customer information more than necessary. Despite accepting a certain level of fraud as unavoidable, these costs and payment uncertainties can be avoided when using physical currency in person. However, no mechanism exists for making payments over a communications channel without a trusted party. From a Shariah perspective, every transaction, whether physical or virtual, is considered a contract, which must fulfill specific requirements stipulated by Shariah.

To address the limitations of the trust-based model, a new form of digital currency has been introduced. This electronic payment system is based on cryptographic proof instead of trust, allowing two parties to transact directly with each other with no trusted third party. Transactions that are computationally impractical to reverse provide protection against fraud for sellers, and routine escrow mechanisms can be implemented to safeguard buyers.

This guide aims to analyze the operation of cryptocurrency systems from the perspective of Islamic finance. Its purpose is to evaluate how Bitcoin, cryptocurrencies and blockchain systems can provide proper information to Islamic-minded investors regarding their potential investments in Bitcoin.

Integration of blockchain and DLT technologies in Islamic finance

Blockchain technology has emerged as a solution to address trust issues in financial transactions. Islamic finance, which promotes transparency and honesty, can benefit from the use of blockchain and other distributed ledger technologies (DLTs). Blockchain is a decentralized ledger that records transactions in a transparent and secure manner, making it difficult to manipulate or cheat the system.

In Islamic finance, blockchain can be integrated with various other technologies, such as AI, machine learning, and image processing. This integration can enhance auditing and monitoring systems, ensuring transparency among all parties involved, including Shariah boards, regulators, and management.

Crowdfunding, microfinance, and Islamic philanthropy management are areas within Islamic finance that can benefit from blockchain-based systems. Blockchain and cryptocurrencies can reduce transaction costs, eliminate cross-border limitations, and increase trust in fundraising institutions. Moreover, blockchain can help detect fraud in crowdfunding and other banking transactions, making it easier for regulatory institutions to monitor and enforce compliance.

Digital currencies, including cryptocurrencies and central bank digital currencies (CBDCs), play a significant role in Islamic finance. They enable cost reduction, increase reachability and inclusion, and align with the objectives of Maqasid al-Shariah, particularly in protecting wealth. However, there is ongoing debate among Islamic scholars regarding the permissibility of certain cryptocurrencies due to issues such as volatility and lack of intrinsic value.

From a Shariah perspective, mainstream cryptocurrencies are often considered to have a Gharar element, indicating excessive uncertainty and risk, which is prohibited in Islamic transactions. Additionally, the lack of intrinsic value and central bank supervision over cryptocurrencies raise concerns from a social justice perspective.

Nevertheless, some argue that cryptocurrencies, including mainstream ones, can be Shariah compliant, and the arguments against their permissibility may not have a strong basis. From a Maslahah perspective, cryptocurrencies can contribute to the development of Islamic society and serve the objectives of Maqasid by increasing overall wealth. Risk in cryptocurrency investments can be minimized through partnerships that apply the structure of Musharakah.

In the context of digital currencies, central bank digital currencies (CBDCs) issued by a central bank and backed by an underlying asset with intrinsic value could address many of the concerns raised. CBDCs allow users to have direct accounts with the central bank, bypassing the need for intermediaries. However, the implementation of a CBDC requires significant investment and distributed ledger protocols, making it less attractive for widespread adoption in economies. Conventional central bank infrastructure is still preferred for directly claimed CBDC designs, except in smaller regions with manageable transaction volumes.

Cryptocurrency in the Islamic perspective

The issue of cryptocurrency and its status as money is a topic of interest, particularly from an Islamic perspective. Cryptocurrency operates on cryptographic principles within the financial system, and its value is determined by algorithms in a blockchain system. While cryptocurrency possesses some characteristics of money, further exploration is needed to ascertain its true nature. Generally, three groups exist regarding cryptocurrency: the cons group, the pros group, and the neutral group.

Cons group

According to Bakar et al. (2017), there are three conditions that exclude cryptocurrency from being categorized as money. First, it lacks intrinsic value. Second, cryptocurrency holders can remain anonymous. Third, it is deemed unstable. Meera (2018) also argues that “Islamic” money should be backed by a tangible asset, which cryptocurrency fails to provide. Nurhisam (2017) raises concerns about Bitcoin’s lack of government regulation, its associated risks, and inherent weaknesses. He emphasizes the importance of money issuance by governments and the need for control.

Pros group

Oziev and Yandiev (2018) assert that Bitcoin aligns with Islamic teachings, as it lacks an emitter, monetary control, and transparency. Some Islamic scholars share different opinions on this matter. The Shariah Review Bereau (2018) considers cryptocurrency and tokens permissible as money due to their ability to facilitate exchange transactions, while meeting requirements such as property (maal), usufruct (manfa’ah), rights (haqq), and liability (dayn). Amalin (2018) argues that cryptocurrency fulfills the function of a medium of exchange, offering transparency and clear regulations for trading. It also avoids usury (riba), which is prohibited in Islamic teachings. Zain (2018) acknowledges the potential for Bitcoin to be used in illicit transactions due to its lack of regulation by a central bank.

Neutral group

Azulbaidi and Abdullah (2017) suggest further study is necessary to determine the compatibility of digital money with Islamic teachings. Asif (2018) states that the system is not inherently against Islamic teachings but may not align with derivatives. Bangash (2017) highlights that early Islamic scholars did not extensively discuss the requirements of money, focusing instead on user behavior. While Imam Ibn al-Qayyim warned against trading money like a commodity to avoid crises, Imam Abu Hanifa and Imam Abu Yusuf permitted treating money as a commodity with certain restrictions. Bangash also expresses concerns about the safety and the speculative nature of Bitcoin. Adam (2017) identifies three requirements for money: wealth (māl), legal value (taqawwum), and monetary usage (thamaniyyah). Bitcoin may fulfill the first two criteria as a store of value and lawful according to Islamic teachings. However, it falls short in terms of monetary usage due to volatility, circulation limitations, and transparency issues. Adam (2018) adds that all types of cryptocurrency coins and tokens may align with Islamic teachings, except for buy-back tokens, which require separate contracts.

Limitation of supply

Another noteworthy consideration is that Bitcoin production will cease after 2140 once 21 million Bitcoins have been created (Koropenko, 2018). Money should have the capacity to accommodate any transaction, necessitating its availability.

The Islamic perspective on cryptocurrency as money remains a topic of discussion, with various opinions emerging from different scholars and researchers. While some view cryptocurrency as incompatible with Islamic teachings due to its lack of intrinsic value, anonymity, and instability, others argue that it conforms to certain requirements for money. Further study is needed to determine the suitability of digital currencies in the context of Islamic finance.

Bitcoin transaction system from an Islamic finance perspective

Bitcoin, as a decentralized peer-to-peer payment network, operates on a system that raises certain concerns from an Islamic finance perspective. Analyzing the issues associated with Bitcoin, we find elements of uncertainty (gharar) that may contradict Islamic financial principles. Here is an assessment of the Bitcoin transaction system based on Islamic finance principles:

1. Unknown Creator: Bitcoin was introduced in 2009 by an individual known as Satoshi Nakamoto, whose true identity remains undisclosed. This anonymity raises uncertainty (gharar) concerns as it is associated with the unknown and unpredictable nature of the system.

2. Decentralized Network: Bitcoin functions without a central authority or intermediaries, relying on its users to validate transactions. Without a central authority overseeing the system, there is a possibility of fraudulent activities. This lack of oversight and validation raises concerns of uncertainty (gharar).

3. Reliance on Cryptographic Hash Function: Bitcoin employs cryptographic hash functions for security purposes. However, this system is vulnerable to hacking and security breaches, which introduces an element of uncertainty (gharar) from an Islamic finance perspective.

4. Lack of Intrinsic Value: Bitcoin exists solely in the digital network and does not have physical form or intrinsic value, such as being redeemable for a tangible asset like gold. Islamic finance principles emphasize the importance of having underlying assets or value, which Bitcoin lacks.

5. Absence of Government Regulation: Bitcoin operates independently of government regulations or laws. This lack of regulatory support creates uncertainty (gharar) and raises concerns about the legitimacy and stability of the system.

6. High Volatility: Bitcoin is known for its high volatility, with significant price fluctuations. Factors such as negative press, security breaches, and variances in perceptions contribute to its instability. The unpredictable nature of Bitcoin’s value raises concerns of uncertainty (gharar) from an Islamic finance perspective.

7. Lack of Option Value for Large Holders: Bitcoin’s limited market adoption and relatively low trading volume make it challenging for large holders of the currency to liquidate their positions without significantly impacting the market. This lack of option value adds to the uncertainty (gharar) associated with the Bitcoin system.

8. Anonymous Transactions: Bitcoin purchases can be made discreetly, without being associated with a user’s identity. This anonymity makes it difficult to trace the real account holder, potentially leading to potential suspicious activities. This lack of transparency creates uncertainty (gharar) in terms of accountability and compliance with Islamic finance principles.

The Bitcoin transaction system raises concerns from an Islamic finance perspective due to elements of uncertainty (gharar). The system’s unknown creator, decentralized nature, vulnerability to hacking, lack of intrinsic value, absence of government regulation, high volatility, limited option value for large holders, and anonymous transactions all contribute to this uncertainty. Islamic finance principles emphasize stability, transparency, and accountability, which may conflict with certain aspects of the Bitcoin transaction system.

Conclusion

We have conducted a comprehensive analysis of cryptocurrency frameworks, with a specific focus on the Bitcoin system, from the perspective of Islamic finance. The purpose was to evaluate the compatibility of these frameworks with Islamic finance principles and provide insights for Islamic-minded investors interested in Bitcoin.

The findings of this study indicate several aspects of the Bitcoin system that raise concerns from an Islamic finance perspective. Firstly, the reliance on public and private keys for transactions introduces uncertainty (gharar) due to the lack of an authoritative entity to validate transaction legitimacy. The absence of monitoring authority leaves room for potential manipulation of the system.

Secondly, the vulnerability of the Bitcoin system to hacking activities further adds to the element of uncertainty (gharar). Transactions, although not encrypted, are recorded in blocks and can be viewed by anyone. This vulnerability raises security concerns and challenges the notion of trust in the system.

Additionally, Bitcoin’s lack of intrinsic value, as it exists only in the digital network and is not redeemable for tangible assets like gold, raises questions about its compatibility with Islamic finance principles, which emphasize the importance of underlying assets or value.

The high volatility of Bitcoin, driven by large holders of the currency, poses another challenge from an Islamic finance perspective. The lack of mass-market adoption and limited option value for large holders contribute to uncertainty (gharar) within the Bitcoin framework.

Despite these concerns, it is worth noting the advantages of low transaction fees and the absence of third-party interference in Bitcoin transactions. These features offer cost-effectiveness and increased freedom compared to traditional financial systems.

In conclusion, while cryptocurrency frameworks, including Bitcoin, may offer certain advantages, their compatibility with Islamic finance principles remains a topic of discussion. The presence of uncertainty (gharar) elements, vulnerabilities, and the absence of intrinsic value raise concerns. Further research and evaluation are necessary to determine the extent to which cryptocurrency systems can align with Islamic finance principles and ensure compliance with ethical and regulatory standards.

Islamic-minded investors considering involvement in cryptocurrencies should approach them with caution and seek guidance from knowledgeable scholars and experts who can provide insights tailored to the specific requirements and values of Islamic finance.

FAQs

What is the purpose of diagnosing cryptocurrency frameworks from an Islamic finance perspective?

The purpose is to analyze and evaluate the compatibility of cryptocurrency frameworks, specifically Bitcoin system transactions, with the principles and regulations of Islamic finance.

How does Islamic finance impact the assessment of cryptocurrency frameworks?

Islamic finance introduces specific ethical and legal guidelines, such as the prohibition of riba (interest), gharar (uncertainty), and maysir (gambling), which need to be considered when assessing the compliance of cryptocurrency frameworks with Islamic principles.

What does the article hope to achieve by taking a new look at Bitcoin system transactions?

By taking a new look at Bitcoin system transactions, the article aims to provide fresh insights and perspectives on the compatibility of these transactions with Islamic finance, shedding light on potential issues and considerations for Muslim users and investors.

What are some key factors considered when diagnosing cryptocurrency frameworks from an Islamic finance standpoint?

Key factors considered when diagnosing cryptocurrency frameworks from an Islamic finance standpoint include the adherence to Shariah principles, avoidance of interest-based transactions, the absence of uncertainty and gambling elements, and adherence to ethical and social responsibility principles.

What are the implications of the findings for the intersection of cryptocurrency and Islamic finance?

The findings can provide valuable information for policymakers, regulators, and Muslim individuals interested in cryptocurrency, offering insights into the permissibility and potential risks associated with cryptocurrency usage in the context of Islamic finance.

Disclaimer. The information provided is not trading advice. Cryptopolitan.com holds no liability for any investments made based on the information provided on this page. We strongly recommend independent research and/or consultation with a qualified professional before making any investment decisions.

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John Palmer

John Palmer is an enthusiastic crypto writer with an interest in Bitcoin, Blockchain, and technical analysis. With a focus on daily market analysis, his research helps traders and investors alike. His particular interest in digital wallets and blockchain aids his audience.

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