Bitcoins, digital tokens and initial coin offerings (ICOs) may be the hot topics in the investment space today and potentially the future of finance tomorrow but amid the fanfare comes a string of warnings from regulators and observers. Singapore this month cautioned the public over the risks associated with ICOs, not long after the US advised investors the same while market pundits are warning of a cryptocurrency bubble. In the larger scheme of things, where does Shariah stand in this? VINEETA TAN finds out that when it comes to money, it’s a complicated ordeal.
More compliant than fiat
To Mark Smalley, blockchain-based digital currencies are more Shariah compliant than fiat money. The co-founder and CEO of distributed ledger tech company Neuroware has on multiple occasions vocalized that blockchains and most of their corresponding cryptographic-based currencies fit the mold of Sunnah money — they hold intrinsic value from the energy used to produce them, they are not based on interest, they are often inflation-proof and blockchain transactions are virtually tamper-proof and transparent.
Many in the Islamic finance circle share Smalley’s views, including Mufti Abdul Kadir Barkatulla who sits on the Shariah supervisory committees of UK-based Al Rayan Bank and United National Bank among others; he sees bitcoin-style cryptocurrency as a potential catalyst for the development of Shariah finance while in Malaysia, Professor Dr Ahamed Kameel Mydin Meera, the former dean of the Institute of Islamic Banking and Finance at International Islamic University Malaysia who is also known as a strong proponent of the Islamic gold dinar, embraces virtual currencies with open arms.
“The current monetary system is unsustainable,” says Prof Dr Ahamed citing the numerous economic and financial crises since 1971 when the US de-pegged the dollar from gold and instead linked the greenback to loans from the Federal Reserve. “It is only a matter of time that the world would move toward digital currencies.”
To Prof Dr Ahamed, who is currently the managing director of Z Consulting Group, gold-backed cryptocurrency is the way forward for the (Muslim) world; in fact, it is likely a better way of making the Islamic gold dinar a reality considering how the world is more accepting of digital currencies.
However, like most products in the Islamic finance world — for better or for worse — differing opinions are common, including for bitcoin — the most popular incarnation of blockchain cryptographic currency.
“If something is accepted as a measure of value and recognized as a medium of exchange, it is deemed as money. This is in its simplest sense,” explains Maya Marissa Malek, the executive director of global Shariah advisory and managing director of Amanie Advisors Global Office which, IFN understands, is working on at least one digital token initiative. “The form of money, though, has evolved over the years. Cryptocurrency is one form of money and as such, from the Shariah perspective, as with other forms of money, it is a Ribawi item, and shall comply with the Shariah rulings related to money for all aspects it is being used for, failing which, that particular transaction is deemed Shariah non-compliant.”
Malaysia’s religious council, for instance, decided about three years ago that bitcoin was not suitable as a medium of exchange as it was too volatile — as a result of being speculation-driven. The Islamic Ulema Council of an Indonesian city contended that the fact that the web-based currency is unregulated means that it is vulnerable to abuse and Gharar, thus any related transactions are too risky and therefore Haram — this view resonates with that of Professor Dr Monzer Kahf of the Qatar Faculty of Islamic Studies who opined that cryptocurrencies like bitcoin are unsuitable to serve as a currency as they are subject to a high chance of manipulation in the open market. Some also take issue with bitcoin not being backed by physical assets.
It is, however, important to note that neither the Fatwa issued by the Malaysian or Indonesian religious councils dismissed cryptocurrencies as Haram per se; rather the legal uncertainties shrouding virtual currencies — and this goes beyond Shariah authorities as banking and finance regulators worldwide are still trying to decide the most appropriate treatment for digital currencies and related activities — and their highly volatile nature make such transactions undesirable and against Muslim sensitivities. Hypothetically speaking, if these elements of volatility and uncertainties were to be removed — and some argue that they would be with time as regulators become more familiar with bitcoin and the market continues to mature – bitcoin could potentially meet Shariah requirements.
These issues, many think, could also be resolved by backing bitcoin (or any digital currency) with a real asset.
“Like any currencies, digital currencies can be made Shariah compliant. It has to be based on real money — just like any Islamic finance transaction has to be tied to the real economy,” Prof Dr Ahamed shares. “Digital currency based on real assets like gold or any commodity, in my opinion, makes it Shariah compliant although some scholars might argue otherwise.”
Asset-backed blockchain cryptocurrency is not uncommon — there is Brickcoin, which is backed by real estate; profit-sharing Sync Coin, underpinned by other cryptocurrencies and premium web domain names; and the likes of OneGram and OZcoinGold offering gold-backed digital currencies. But it takes more than just being backed by assets to meet the requirements of the faith.
“Technically, if a digital currency has a value, which can be independently verifiable and has an ownership linkage between the digital currency and that commodity/asset, then it is perfectly fine. But if there’s no linkage, and it is only on a notional basis, then such currency/asset cannot qualify for the Shariah eligibility test,” Mian Muhammad Nazir, CEO of Dar Al Sharia, explains.
If one were to be pedantic, technically, bitcoin is not a currency yet, according to Mian, because there’s no value attached to it that can be independently verifiable, freely exchangeable and there is no acknowledgement, being no receipt. “It is based on a complex mathematical code (not independently verifiable and also does not purport to create a tangible asset or service) which is in the hands of the people — it is notional, ambiguous, uncertain and even does not qualify to serve as a receipt or acknowledgement of a price, reward or compensation for the purchase of an asset or service rendered which can result in a crystalized monetary claim or entitlement.”
In the interest of intellectual debate, let’s say that bitcoin and virtual currencies are indeed Shariah compliant, this still does not take cryptocurrencies out of the grey area. Just ask Robin Lee, the founder of HelloGold, a Kuala Lumpur-based digital gold trading platform.
The former World Gold Council CFO insists that its planned global fundraising exercise, to launch on the 28th August in Singapore (See IFN Fintech August Issue), is not an ICO but a token sale. HelloGold this week sold 40 million tokens raising about US$1 million through its pre-token sale, a minimum threshold it set as an indication of a successful pre-launch sale.
And a growing many in the digital currency community would stress to make that distinction as well because ICOs are often compared to IPOs, and this is where things can get tricky.
For starters, ICOs are not regulated. And it remains outside the purview of regulators because they are essentially selling cryptocoins or virtual tokens to raise money in exchange for legal tender or other digital currencies offered by the issuer, not equities (therefore voting rights) like that of IPOs.
While many treat ICOs synonymously with token offerings, some disagree, simply because tokens do not necessarily mean money.
Take OneGram and HelloGold for example. OneGram is clear that the OneGramCoin (OGC) is a Shariah alternative to fiat currency; HelloGold on the other hand, whose gold investment product is certified Shariah compliant, is clear that its tokens — sold through the HelloGold Foundation — are not a currency but rather rights to future services or utilities. A portion of the OGC ICO would be reinvested to buy more gold to back the OGC, and one can also look at the ICO as a distribution of the currency rather than a pure fundraising exercise; the sale of HelloGoldTokens (HGT) is used to raise capital to fund its expansion plans, and holders of HGT have the opportunity to be rewarded in gold-backed tokens by the HelloGold Foundation depending on its gold under management.
On the other side of the coin, you have the venture capitalists and private equity players who are tokenizing their equity or funds and selling them as if they are a representation of a security. In cases like this, the rules — security and Shariah regulations — apply because it is obvious that these tokens are a security. But tokens as rights to a future utility fall into ambiguous territory.
Then come the hedge fund managers who are launching digital currency funds investing in virtual currencies like bitcoin and Ethereum. In this case, digital currencies have morphed from being money into an investment asset class, a commodity. While commodities with intrinsic value (gold, silver, barley, dates, etc) can be considered as money in Islam, money in itself has no intrinsic value. It is only used as a medium of exchange, a unit of account and a store of value. And to invest into a fund which invests in money, that may be tantamount to making money out of money, or Riba, which is forbidden in Islam.
“In my opinion, currency is supposed to be [a] medium of exchange of value, not a commodity. It cannot be an investment and cannot be treated as a commodity,” says Prof Dr Ahamed.
Brave new world
From being a currency to a fundraising tool to a security and to an investment asset, digital money can and is complicated. While scholars have issued (varying) opinions on digital currencies (and the trading of virtual money), the topics of ICOs (except that of OneGram) and digital currency funds have not been delved in-depth.
And this is not only a Shariah issue — worldwide, regulators are also trying to find their footing in the realm of ICOs, token sales and digital currencies. Should tokens be treated as a securitization? Or as a fundraising means like that of crowdfunding? Even so, which type of crowdfunding? If it is a token sale with (unguaranteed) rights to a future utility, it could fall under reward-based or donation-based crowdfunding — and even that is generally beyond the scope of capital market authorities.
A few weeks ago, the Securities and Exchange Commission of the US warned entrepreneurs and investors about potential risks of ICOs and token sales and stressed that the US federal securities law “may apply to various activities including distributed ledger technology, depending on the particular facts and circumstances, without regard to the form of the organization or technology used to effectuate a particular offer or sale”.
Since the warning was issued on the 25th July, fundraisers struggled to come close to the record-high US$665 million raised through 34 coin offerings in the month of July (double what was raised from January-May).
According to Token Data, month-to-date, issuers only managed to attract US$117.66 million through 38 sales; however, 59 launches are in the pipeline and another 133 are still ongoing, suggesting companies are still keen on the ICO path.
But the ramifications of not being able to properly regulate or box cryptocoins into proper categories can be problematic. Investor protection aside, there are issues with taxation for example: should it be treated as an asset or liability and how should companies which raise tokens or hold tokens be taxed? And of course, a major concern is the laundering of money. An unregulated system is one that is vulnerable to abuse.
So what next?
Ideally, the Islamic finance industry should come to a consensus about how to treat this new ‘creature’ so to speak. But in reality, this is going to take time, and even a series of trials and errors, because this is unchartered waters.
“What we need is not a burst of cursory Fatwas and other brief remarks, but the sponsorship of scholarly research papers on the position of cryptocurrencies and Shariah,” emphasized Mufti Abdul Kadir in a previous opinion piece.
And realistically speaking, there may even be new permutations: bitcoin and Ethereum, the world’s two most valuable digital currencies, are perhaps the best illustrations of this point. They were both created with clear goals by their inventors: bitcoin as a pure currency, medium of exchange, and Ethereum a platform for individuals to build apps; but they have both evolved to become more than that — bitcoin as an investment asset, a tool for speculation and hedging, and Ethereum as a currency (also investment asset).
Just like how opinions of Shariah scholars may differ from one to another, the intent of the inventor and the intent of the user often could also diverge.
But does this mean Shariah investors should completely denounce cryptocurrencies and tokens?
Prof Dr Ahamed cautions against it and asks to be realistic in managing ideals and reality. “I am a strong proponent of gold-backed currency but I still carry fiat money in my pocket; otherwise, I won’t be able to buy anything in the supermarket. I can tell what is good for society, but I can also tell what is the present situation we are in.”
We are in murky waters and until the regulators take a formal stand, there would probably be more questions than answers. Until then, investors, users and issuers are to exercise caution and self-discretion, at their own risk and of course, conscience.