Islamic finance and Islamic investment options have been around ever since the beginning of the 20th century and they have continued to be an intriguing topic of discussion among many Shariah scholars. ARSHAD KHAN writes.
As we all know, in Islamic finance, Riba is forbidden as the Quran and Hadith have discouraged it multiple times. That aside, short-selling and speculation are also practices that Shariah scholars have been concerned about. Due to issues related with Riba, lending and borrowing have been challenging in Islamic finance. Lenders cannot lend and borrowers cannot borrow against interest or Riba.
To overcome the issues around Riba, Shariah compliant lending and borrowing firms have structured instruments in which lending and borrowing can be undertaken in Shariah compliant ways. Also, Shariah compliant investors have developed products in which they can enter into the conventional financial securities without breaching the principles of Shariah.
Most of these products and instruments have been structured by using commodities as an underlying asset or collateral. This has contributed to the global trade in commodities and has been one of the reasons for the trading growth in commodity products. For decades, Shariah compliant investors have had unique reasons for participating in the commodity markets. They have used metals, such as copper, aluminium and platinum, to undertake the transactions that would otherwise fall short of the laws of Shariah.
Financial institutions and Islamic traders used cash deposits and an innovative form of derivatives that fall under Islamic laws. Commodities were the center of these new instruments and have been very effectively used to comply with the central tenet of Islamic finance. All returns must be derived from a genuine source of business activity, and asset-backed transactions.
For lending and borrowing in a Shariah compliant way, Murabahah instruments have been used predominantly. Lenders and borrowers would sell and buy commodities, for example copper, and structure the deal in a way that the transaction is backed by an asset which changes ownership at each of its leg, thus making the structure more reliable and less prone to risk. Murabahah transactions are not something new, and traders have been using metals and other commodities such as palm oil and crude oil for ages to undertake these deals.
Other types of investment vehicles have also been constructed to comply with Islamic finance laws, such as currency swaps. In their original format, currency swaps are types of investment vehicles in which two parties exchange an equivalent amount of money with each other but in different currencies. The parties are essentially loaning each other money and will repay the amounts at a specified date and exchange rate.
In order to make these transactions more compliant with the Islamic finance laws and regulations, when there is a shift in Currency A versus Currency B, Party B would sell Party A some metal at a discount to the market value. Party A would then sell the metal at the market price and treat the gains as a profit.
There are many other forms of investment that are making the rounds in the Islamic finance field, and with the recent boom in cryptocurrencies, there was bound to be a Shariah compliant cryptocurrency. One such coin exists and is called Caizcoin. This coin was founded in Germany and was introduced into the market after a year of its founding.
Such similar attempts have been made to issue digital tokens which are backed by commodities particularly metals. Gold-backed tokens have also been introduced with some Shariah scholars terming them as Shariah compliant.
But this begs the question: are not other cryptocurrencies or digital assets Shariah compliant? Well, the question is a bit tricky to answer as there are many views surrounding this issue. One of the key fundamentals in Islamic contractual laws is that a transaction must have an exchange of Mal. Mal literally means something that can be possessed or acquired.
So the key topic is whether cryptocurrencies and blockchain currencies are considered Mal. The three main views are as follows:
1. Cryptocurrencies are not Mal, and they are purely speculative and thus not Shariah compliant.
2. Cryptocurrencies are digital assets and not an actual currency, but since they adhere to the properties of Mal, they are considered to be Shariah compliant.
3. Cryptocurrencies (of certain kinds) are currencies, and hence are Shariah compliant.
We can continue to argue and explain whether these views are correct or not, but at the end of the day, we won’t yet find a definite answer. Globally, Shariah scholars continue to debate the treatment of cryptocurrencies under Shariah principles. Considering the early days of this asset class, several views have been given but it remains under discussion before a wider accepted opinion is formed.
The recent increase in the use of cryptocurrencies and the acceptability of DeFi [decentralized finance] applications will certainly have an impact on the ongoing debates and the resulting final opinion.
It will be a very interesting space to watch out for, as Islamic finance continues to innovate with its product offerings, as with the digital assets as well. Both will find common ground in times to come as they serve an important objective that the future of the financial system would like to achieve.
Note: The above thought piece covers the wider virtual assets industry, and may not be an activity that Arabian Bourse is looking to be licensed to undertake.