Note: This document has been translated from its original published Arabic whitepaper and it is still under review by the author Dr. Salem. We will publish the reviewed version of the document once we receive it from the author. (link to the original document can be found at the footer of the article).
Praise be to Allah, and may blessings and peace be upon the Messenger of Allah, his family, and companions, and whoever allied him.
I would like to caution the readers that I am not a specialist in coding and computer programming, but I have benefited a lot from the specialists in this field. The discussion focused on issues that I regard worthwhile avoiding definitions and details available in public resources. Allah is our sources of success.
Crypto money is money issued through computer programs using cryptographic techniques "encryption". So that the data on which encrypted currency is issued is protected with a high degree of accuracy and strength.
There is a big difference between electronic money and encrypted money. All encrypted money is electronic, but the opposite is incorrect. Most of the currency currently used through the banking system are electronic money. The percentage of paper money does not exceed 3% of the total cash mass. 97% of which is an electronic currency. Bank money is also encrypted but not at the same power level and sophistication as cryptocurrency.
The term virtual money is sometimes used to express encrypted money, but in my opinion, it is inaccurate because it is hypothetical. If it is intended to be intangible, such as paper or metal money, then this means that it is electronic, and we have already talked about it, but If it means that it is not official cash or not recognized by the official authorities, then this includes other forms than encrypted money.
It is worthy to mention an important term in this context, which is “Token”. It means a code or a ciphered receipt that symbolizes a right or a financial asset or otherwise. Encrypted money is a type of symbols, but not every symbol is a cryptocurrency.
What is new in cryptocurrency?
What is new is the technology cryptocurrency is is built upon, and this technology is blockchain technology. This technology relies on a decentralized database, which means that there is a copy of it at all the participating members of the network or organization involved in the issuance of this currency.
This database records the transfers of ownership of cryptocurrency or any other commodity from one person to another. Each group of operations is collected into one package or block, and then this block is encoded. No new operation is added to the block until it is verified and authenticated by the members.
The blockchain system aims at especially important functions that are.
Since the information is encrypted within a decentralized database, which means it is located on several devices of independent members. The reliability, the verification and the documentation of the data and information becomes high due to the inability of many independent members to be complacent in the forgery or tampering of data components in the database.
The blockchain system has succeeded in solving the biggest problem facing electronic money, this problem is known in the professional field as “Double Spending”, which is similar in the Islamic finance to selling what you do not own. A person may use a specific cryptocurrency to buy a commodity and then use the same cryptocurrency to buy another commodity, even though the currency is no longer his property due to the first purchase. This problem is especially prominent in electronic currencies due to the ease of use in more than one process.
The blockchain system was able to solve this problem by recording the data of each transfer of currency ownership in a database stored by many network members. These members act as witnesses to each transaction. With this certification, the possibility of forgery, fraud, or selling of what is not owned becomes virtually impossible, especially if the network expands and the number of members in the blockchain system increases. In short, it is a highly developed certification system.
Verification and incentives
Block technologies require a mechanism in place to motivate members to participate and compete to validate the transaction. The competition is organized according to a specific mechanism that differs from one cryptocurrency to another, which the reader can finds it explained in the context.
The objective of all transactions is closure and legitimacy. As part of a wisdom and instinct, individuals will always seek that which benefit them and not harm them. But there are cases in which the interest of the individual conflicts with the group, and the long-term interest conflicts with that of the short-term, it is in these cases that Sharia intervenes in directing or restricting these transactions. Therefore, we will not address all the applications or details of encrypted currency, but rather we will limit ourselves to the most important of them, which calls for consideration and discussion.
Initial Coin Offering
Initial Coin Offering (ICO) is like Initial public offering (IPO) for investors. In the case of cryptocurrency, the offering is cryptocurrency, not stocks or securities. The investor in the first issue of cryptocurrency aspires to sell it after subscribing for a profit, as is the case with shares.
The difference between stocks and cash is that stock represents ownership in the company, while cryptocurrency does not represent any ownership. This fact may not raise any issues because cryptocurrency is designed to facilitate financial transaction, however, problems arise from the issuing company at the time of establishment.
For currency to perform its function, it must be accepted, even from a limited group and to get acceptance the issuing body must have credibility. The issuing body issues the coin to gain credibility and recognition, so the cryptocurrency issued to gain credibility becomes the source of credibility for the issuing body. Here lies a contradiction. The issuing body is still in the foundation stage, therefore, It issues cryptocurrency to gain credibility and recognition. So, the cryptocurrency, which lacks credibility becomes its own source of confidence. This pattern often leads to a bubble that results in loss for the investors.
This is the reality: more than 50% of initial coin offering end in failure within the first four months, according to a study prepared by researchers from Boston College in the United States. This is a logical consequence of the vicious circle that the initial coin offering represents. Cryptocurrency cannot be a source of credibility and recognition when the source issuing the cryptocurrency depends on the source for its credibility and recognition, because this leads to a bubble soon to burst.
This result is consistent with the view of several contemporary scholars regarding a strong relation between cryptocurrency and obscene fraud. However, the problem is not with cryptocurrency but rather with financing cryptocurrency in this manner.
Sale Prior to Validity
It should be noted that the shares of companies under establishment are subject to the Sharia law prohibiting selling before validity. This rule applies generally to all commodities. Acquiring company's shares at the time of establishment is not included, if the acquiring is done at nominal value (i.e., there is no share premium). There is nothing wrong with acquiring shares at the time of establishment. However, there is a problem when buying shares in a company when it has not yet produced gains or profits, which is the indicator or viability.
The companies under establishment are companies in which the signs of economic maturity have not been achieved, so to speak, and that is why they are called under establishment, they are more like a fetus that has not yet been born or crops that are yet ready for harvest, and at this stage it is subject to loss or struggle for many reasons. The purchase or sale of the company's shares at this stage is based on the hope of profit that has not yet materialized. Therefore, most countries in the world prevent the founders from selling shares in the company under establishment except after a specific period has passed (in the American system, for example, six months, and in the Saudi system two years). This is because of the fear that founders may benefits from the market before the company comes to maturity causing the investors losses.
This means that the investors did not contribute to establishing companies but acted in the hope that other investors who would contribute by buying shares and do the following wave of investors and so. Even if the number of investors decrease, the latter will have paid the price when the market collapse. This pattern of making money is called the hierarchy or the Ponzi system, and it is a substantial loss for the last generation of investors. This method makes the market simply system that exchange money for money without regard to what is being bought and sold. The market becomes a zero-sum system that does not added value to the economy and resembles more a gambling casino than a market.
The sale of encrypted currency through ICO is just as fraudulent as IPO during the establishment stage and may even surpass it because it includes the same transgression of exchanging of money for money or cash for cash, and above that, cryptocurrency is free of any kind of ownership guaranteed by buying shares.
The process of the initial cash issuance reveals one of the most important types of defects in contemporary financial systems, which is the deviation of cash from its primary function, which is to facilitate exchange, and turning it into an investment asset to generate profit, cash has known functions:
Exchange requires spending money and not keeping it, while investment requires keeping it for profit. There is no problem in trading investment assets, but trading for these assets continues for the purpose of investment. Unlike cash, trading is the principal and keeping it dependent. The two functions are inherently contradictory and cannot be combined in criticism.
This shows one of the harms that result from usury. Usury turns any loanable commodity into a profitable asset. This is what precludes spending on this commodity and forbids it from free circulation. Most of the loanable goods are not investment assets but consumer goods. That is why usury is by its very nature contradictory to the sale. The words of all might Allah in the Qur’an collaborate this “God permitted sale and prohibited usury.” This is most to an investment asset contradicts the function of cash. This is the main problem facing risk-based cryptocurrency. Unfortunately, this includes a lot of cryptocurrency, including Bitcoin and others.
The first alternative for company requiring funds is issuing equity shares, which can allow stockholders to monitor and hold the company accountable. There is no stipulation that prevents the shares to be valued in cryptocurrency to avoid the previously described contradiction. The company, when issuing shares, derives its power from stocks and not cash, and the source of profit is stocks and not cash.
The trend now is offering financial tokens (STO) has spread. "Token" is a document that proves ownership of a financial asset. The difference between "Token" and shares, are certificates, or “Sukuk”, is technology and the possibility of including smart contracts for documentation, unlike standard certification. This is a response to the failure in the IPO markets mentioned previously.
Smart contracts are contracts that can be executed electronically if the conditions for it are fulfilled. For example, programming sales execution of the sale order if the price falls to a specified amount. It is a well-known formula in the financial markets, but it falls in principle under the concept of smart contracts.
Islamic jurisprudence recognizes what is called suspension of contracts. That is, suspending the implementation of the contract bending obtaining specific conditions. Basically, the foundation of any contract is execution; therefore, there is nothing in principle to prevent the contract from being executed unless it leads to usury or gambling.
One of the most important uses of price is us in borrowing and buying at a deferred payment. In both cases the price is stated in the financial disclosure. There is no dispute among scholars that disclosure requires existence of currency. The basic assumption is that cash is generally available, present and is never in shortage to affect conditions of sales or purchase. So, does this also apply to cryptocurrency? Most types of crypto money are not constantly available to public and is only issued on demand, this means that it cannot stated in financial disclosure, thus the issue requires further studying.
When a transaction is executed with bitcoin it takes approximately 10 minutes to be validated. This duration may exceed that time in some cases. For other currencies, the duration may be more.
If a transaction is a currency exchange, then cashing is a stipulation that must be achieved. The question her is does this delay required affect the exchange transaction? It seems that from a Sharia point of view it is allowed in this case, because the delay is essential for validating the transaction and not to prolong it. It is as dirhams were exchanged for dinars and each party wanted to examine the cash and ensure authenticity. The examination or test does not go against contradict the exchange transaction, which solidify the contract.
This is explained by the fact that when the transaction is rejected and no exchange happens, the contract becomes invalid. What is prohibited is delayed cash contracts because it leads to credit and usury.
This shows that if the transaction is rejected, the contract is void and no ownership is transferred to the other party. The delayed payment contract is prohibited because it leads to debt and then usury.
If the contract is concluded pending verification of the validity of each party which begins immediately after the conclusion of the contract, it is not an excuse debit, but rather the opposite. Verifying the validity of the transaction prevents the confirmation of the debt because the latter is a branch of the transfer of ownership, and ownership is transferred only by verification. Delayed cash to verify the validity of the transaction does not entail transgression on sharia.
Al thanks to Allah Almighty.
If you have any problem understanding any of its content, please refer to the original paper.
Source: النقود المشفرة: نظرة تأصيلية