The Shariah factor in Cryptocurrencies and Tokens

A cryptocurrency is a form of virtual currency that uses cryptography to verify that any person who attempts to spend some of the currency is the person entitled to do so. Cryptocurrencies typically use a decentralised peer-to-peer network to verify transactions and to record them on a decentralised public ledger (which is commonly known as a blockchain).

Transactions using a cryptocurrency are typically made over a decentralised peer-to peer network without recourse to a bank or central authority. Each transaction is recorded on a public ledger (or blockchain) that is publicly available to all users. A user wishing to make a payment, issues payment instructions, which are disseminated across the network. Cryptographic techniques are then used to enable the network to verify that the transaction is valid (i.e. that the would-be payer owns the currency in question). This contrasts to a traditional bank deposit where the relevant bank will hold a digital record of transactions and is trusted to ensure the validity of that record.

Token or Coin

The paper makes a distinction between coins and tokens, as the two terms are often interchanged in media coverage. A coin is a unit of value native to a blockchain. It is a means of exchange within the blockchain to incentivise the network of participants to use the blockchain. The sole purpose of a coin is to exchange value, and it has limited functionality beyond that. Cryptocurrencies like Bitcoin, Ether, Ripple, and Litecoin are all examples of native coins. In the Bitcoin network, the coin is bitcoin [BTC], in the Ethereum network, it is Ether [ETH]. Typically, there are only two things that can be done with a coin: (i) to send it to someone else and (ii) to pay for transaction fees in the system. If it can do more, it is a token.

Start-ups and mature companies have taken advantage of Ethereum’s smart contract functionality by building decentralised applications (Dapps) on top of Ethereum and creating their own unique tokens. Over time, a token standard called ERC-20 has been adopted which enables interoperability of tokens on the Ethereum network. The token standard governs a set of functions for each token, which in essence creates a template by which other ERC-20 compliant tokens can be cloned in a relatively simple manner. Companies that create tokens using the ERC-20 standard benefit by being able to interface easily with other tokens (for example, exchanging one token for another). In turn, this network effect increases the value of individual Dapp tokens. The majority of Initial Coin Offerings in the market today are the sale of tokens per the ERC-20 token standard for an Ethereum based Dapp.

Shariah factors to Tokens & Coins

When discussing the Shariah technicalities of tokens, the paper unravels what each token can represent from a Shariah perspective. If the tokens entitle one to a service, use of something or utility on a protocol, then the utility tokens would be classified as al-Huqūq al-‘Urfiyyah (customary rights). According to the classical Maliki, Shafi’i and Hanbali jurists, such tokens would be classified as Māl (property). Equity tokens represent a share in a company that has completed a token sale. This will be similar to trading in shares and investing in IPOs. From a Shariah perspective, the same rulings which apply to shares will apply to equity tokens. A business activity screening and a financial screening will be required before investing in such an ICO or network. When trading asset-backed tokens, the Shariah principles of buying and selling must be considered before trading such tokens.

The paper thereafter discusses the Shariah considerations of coins. Currency coins refer to cryptocurrencies like Bitcoin, Litecoin, Ripple, etc. that are recorded in transactions on blockchains indicating only a change in a numerical value. They act as online currencies and are used as a peer-to-peer payment system without any other function. In currency coins, there are two types: coins which are accepted by merchants and those coins which are not accepted by high street merchants and companies beyond the network.

From a Shariah perspective, since both types of currency coins were launched to serve as a peer-to-peer payment system and have been regarded as a payment system, they will be currencies. The Ta’amul (common usage) and Istilah (social concurrence) among users of these coins is that of a currency and medium of exchange. The only difference is, Bitcoin has a wider acceptance as opposed to Litecoin and Ripple. Bitcoin has become a currency as a result based on ‘Urf ‘aam (widespread custom). Currency coins which are only a means of payment in their networks are currencies due to al-‘Urf al-Khās (exclusive custom). Al-‘Urf al-Khās refers to a practice or understanding exclusive to specific people. This specificity can be a result of location, profession, membership or agreement among a group of people. Shaykh Mustafa al-Zarqa argues that this type of ‘Urf is innumerable as the needs of people and their interests (Masalih) are innumerable across time and space. Thus, it is plausible to assume the formation of an exclusive custom built on a blockchain.

Views, Value and challenges

The paper ends with a discussion on the different views in the market regarding cryptocurrencies. Some scholars argue that there is nothing in existence when considering cryptocurrencies. They state that there is no underlying asset or entity. The notion of some ‘thing’ being there even if not tangible has been overlooked. The fact that your money is exchanged into a ‘thing’ which can be used to purchase fiat currencies, items and services negates the assumption that there is nothing there. There is a conversion; something else comes into your ownership and possession and you lose your ownership to your fiat currencies. Thus, there is a reality to this phenomenon.

Value is a concept; something people have social concurrence on. Value is something which attracts Mayl (inclination). This value is the meaning and notion which underpins cryptocurrency digits. The value in the cryptocurrency is there due to the practices and inclinations of the people. The digits shown as a balance in digital wallets and on the public ledgers represent a value in the minds of people. People have an economic inclination to it and have economic benefit from these Bitcoin. All other issues with regards to volatility, laundering, black markets etc. are all external matters which need controls and regulation to address them.