Bitcoin and Islamic Banking: An Overview
Islamic banking is a hot topic in the Gulf Cooperation Council (GCC) nations at the moment, with the United Arab Emirates emerging as a global leader in Sharia-compliant bond issuance. With GCC country regulations of Bitcoin undergoing change in 2023 and 2024, we asked ESW's Middle East and North Africa (MENA) Editor Ahmed to provide an introduction to this topic for our readers around the world.
-- James Smith
Editor-in-Chief and Publisher, ExitStrategy.World
January 5, 2024
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The invention of Bitcoin in 2009 and other cryptocurrencies has catalyzed a seismic shift in the landscape of finance. Now that it has become possible to conduct one's entire financial life (including paying taxes in certain BTC-friendly jurisdictions) using the world's first and most successful digital currency, this remains a unique concept, at a time when conventional banking is still dominant across the globe.
As these digital assets ascend to prominence, pertinent questions arise regarding their alignment with various financial models, including the landscape of Islamic banking. Under Sharia (Islamic Law) principles, which strictly prohibit usury (Riba) and emphasize ethical and equitable financial transactions, Islamic finance provides a distinctive lens through which to examine the intersection with Bitcoin. This essay delves into the multifaceted dynamics of this convergence, probing the challenges and opportunities that arise when these ostensibly disparate systems come together.
At its core, Islamic banking is firmly anchored in the principles of Sharia, the Islamic legal framework. A fundamental tenet of Islamic finance is the absolute prohibition of riba, or usury, as mandated by the Holy Quran. This prohibition extends beyond charging interest to foster an economic system grounded in fairness and ethical conduct. Instead of the interest-based model prevalent in conventional finance, Islamic banking centers on profit-and-loss sharing arrangements, risk-sharing, and ethical investment principles. Obviously activities that violate Islamic morality, such as producing or selling pornography, brewing or profiting from alcohol sales and investments in casinos (which are also prohibited according to the charter of Christian investment institutions such as the Vatican Bank) are forbidden (haram).
The Key principles of Islamic or Sharia-compliant finance are the following:
Prohibition of Riba: The unequivocal prohibition of charging or paying interest is the cornerstone of Islamic banking principles.
Risk-sharing: Islamic finance encourages partnerships and profit-and-loss-sharing agreements, ensuring that both parties share in the risks and rewards of a transaction.
Asset-backed financing: All transactions must be backed by tangible assets, promoting real economic activity and preventing speculative excess. Avoidance of speculative activities: Transactions that involve excessive uncertainty (gharar) or speculation to the point of gambling (maisir) on non-productive activities such as sporting events or e-sports would be actively discouraged.
When outlining the key and core principles of Islamic banking, the challenges and problems facing Bitcoin in the framework of Islamic law become obvious, which include, but are not limited to :
Volatility: Bitcoin's reputation for extreme volatility stands as a significant impediment to its widespread adoption in Islamic banking. Stability and predictability, highly valued in Islamic finance, are compromised by the inherent uncertainty surrounding Bitcoin's price, potentially violating the principle of avoiding excessive uncertainty.
Undefined Underlying Assets: Islamic finance mandates that transactions be backed by tangible assets (such as Gold, Silver, Salt, Dates, etc…). Bitcoin, being a digital asset with no physical presence, challenges this principle. Unlike traditional commodities or assets, Bitcoin's intangible nature complicates its classification in Islamic finance.
Lack of Central Authority: Islamic finance often relies on central authorities to ensure compliance with Sharia principles. Bitcoin's decentralized nature, while offering benefits like transparency and privacy, raises concerns about the absence of a central regulatory body to enforce Islamic finance guidelines.
Anonymity and Security Concerns: The anonymity associated with Bitcoin transactions may raise questions about transparency and traceability, which are crucial in Islamic finance to prevent fraudulent activities and ensure ethical practices. It is hard to regulate and punish offenders who rely on the Internet anonymity afforded by the dark web.
Regulatory Uncertainty: The evolving regulatory landscape surrounding Bitcoin adds another layer of complexity to its integration into Islamic banking. The lack of clear guidelines may hinder the adoption of Bitcoin by Islamic financial institutions, causing hesitation among potential stakeholders.
However, it is important to note that there is a debate between Muslim scholars about whether bitcoin is permissible from an Islamic perspective. Just recently, a 90-year old cleric from Saudi Arabia by the name of Abdul Rahman Nasser Al-Barrak has deemed it permissible, here is some of his reasoning:
“[..] what makes it more likely to say that it is permissible – in my opinion – is that as long as this currency is backed by those who issued it, it is acceptable. Because then they resemble checks issued with amounts divided on a current account balance.”
Continuing, “Obviously, the source must be known [no anonymous BTC transactions - eds]. Because trust in it depends on trust in its source, as is the case with all other currencies, and therefore the same rules that apply to current currencies such as paper money apply to it. Usury is prohibited, the hand of the thief is cut off, its owner becomes rich, it is inherited by him, and zakat [alms-giving a pillar of traditional Islamic piety with donations and community support for poor Muslims - eds] is required. Although its nature and management methods are different from those of traditional currency, Allah knows well what to do.”
It is important to note that this is simply one influential Saudi cleric's opinion and that other opinions based on their interpretations can be had, as this topic is still subject to debate in Muslim countries.
It is important to note the opportunities and positives that the introduction of BTC can have in the framework of Islamic banking, and that while there are challenges, these all have their solutions.
Blockchain Technology - Beyond Bitcoin itself, the underlying blockchain technology holds promise for Islamic banking. The transparent and decentralized nature of blockchain can enhance the traceability of transactions, addressing concerns about anonymity and ensuring compliance with legal and ethical standards.
Financial Inclusion: Bitcoin has the potential to be a force for financial inclusion, a key objective in both Islamic finance and modern banking. Decentralized financial systems can provide access to financial services for the unbanked or underbanked populations, among whom there are 100s of millions of Muslims worldwide, aligning with the principles of economic justice in Islamic finance.
Fintech Innovation: The intersection of Bitcoin and Islamic banking can catalyze innovation in financial technology (Fintech). Smart contracts, for example, can facilitate Sharia-compliant agreements, automating processes and reducing the risk of non-compliance.
Global Transactions: Bitcoin's borderless nature will facilitate cross-border transactions, enabling Islamic banks to engage in international trade more efficiently. This aligns with the principles of Islamic finance that encourage fair and equitable global economic participation. It can also create more financial services connections between Sharia-compliant banks in the Middle East and rising Muslim populations of South Asia (India, Pakistan, Bangladesh) and Southeast Asia (Myanmar, Malaysia, Indonesia) and African nations.
Diversification of Savings and Portfolios: Bitcoin, often referred to as "digital gold," can offer Islamic investors a potential avenue for portfolio diversification. This is particularly relevant as traditional asset classes may not provide sufficient diversification in a rapidly changing global economic landscape. Muslims in Egypt and Lebanon in particular suffer from rapid depreciation of national currencies and are in practice limited to holding gold or paper dollars and euros as hedges against inflation.
Educational Initiatives: Bridging the gap between Bitcoin and Islamic banking requires educational initiatives. Establishing programs to enhance understanding among Islamic scholars, financial institutions, and the general public will be pivotal in fostering acceptance and integration.
In conclusion, the intersection of Bitcoin and Islamic banking is a multifaceted and evolving landscape that demands careful consideration of both technological and ethical dimensions. While challenges such as volatility, anonymity, regulatory uncertainty in the GCC and other Muslim nations, and the lack of central authority persist, opportunities for synergy exist through blockchain technology, financial inclusion, fintech innovation, and improved global transactions. As the discourse continues, a collaborative effort is imperative to create a framework that promotes financial innovation while upholding the principles of economic justice and ethical financial practices in the realm of Islamic banking.
Balancing innovation with adherence to ethical principles will be crucial in navigating this intersection and shaping the future of finance in a manner that aligns with the values of both Islamic banking and the broader global financial community. As the world grapples with the implications of digital currencies, a thoughtful and inclusive approach will be necessary to ensure the development of a financial ecosystem that respects the unique principles of Islamic finance while embracing the transformative potential of Bitcoin.