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26 February 2024
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Shariah Law Opens to Crypto Trading, but Full Adoption Highly Unlikely

Even though in most western countries today, matters related to religion and money have been independent of one another. However, in Islam, especially those following the Shariah code of ethics, the two are intertwined inextricably. Also, in the past, there have been serious efforts to introduce crypto within the world of Shariah-based cooperative finance, such as the Stellar Network and Halal Chain. By and large, this market is still quite nascent and not as mature as many from within the region would like it to be.

In this regard, according to a landmark announcement made by the Securities Commission of Malaysia’s Shariah Advisory Council, trading of digital assets is now permissible by law within the country’s borders. The new ruling will not only help spur the growth of Malaysia’s existing financial ecosystem but will also enable the creation of a blueprint that can be used by other Shariah-observing nations to promote crypto innovation while staying in line with the deep ethical values outlined by Islamic traditions.

To better understand how crypto fits in with the Shariah scheme of things, Cointelegraph reached out to Adlin Zulkefli, a Shariah designated officer representing Masryef Management House — an advisory firm on Islamic finance. In her view, a normal crypto spot trade for investment purposes is deemed permissible by the Shariah code of finance. However, other activities may be seen as haram — actions that lay in direct conflict with the Shariah code of values — and they will not be permissible. She added:

“Shariah law is compatible with the digital asset token if it’s recognized as an asset. Additionally, there should be underlying value or utility to the digital asset, the issuer’s business or cause should definitely be guided by Shariah standards.”

In general, Shariah-compliant digital assets can operate as any other conventional digital offering, but several key differences still exist, such as (1) they cannot be used to make investments in companies in sectors that are not Shariah-compliant; (2) certain requirements need to be met so that investors are treated equally; (3) the inability of users to utilize conventional financing or invest in companies highly leveraged with conventional debt, and (4) the requirement for oversight of investment activities and investments by a Shariah Board.

Shariah’s financial guidelines are flexible in nature

On the subject of whether scriptural precedents can potentially impede the growth of crypto-based finance in the Middle East, Babak Behboudi, the CEO of fintech firm Synchronium, told Cointelegraph that Shariah rules have always been progressive and are constantly being updated by Islamic experts in accordance with the circumstances and advances surrounding any new technology.

However, he did concede that due to the fact that even the basic idea surrounding cryptocurrencies is totally new to Islamic Shariah, it might take some time for experts to distinguish them from haram activities. Behboudi also pointed out that before the rise of cryptocurrencies, a similar issue of Sharia compatibility was also observed in relation to stock market trading when it first started to gain mainstream traction across the Middle East. 

Lastly, since Islamic regulations are quite sensitive when it comes to determining the source of money being used to carry out any transactional activity, cryptocurrencies — thanks to their transparency-oriented frameworks — can be quite useful when issuing, distributing and trading funds in a Sharia-compliant manner. Behboudi believes that adoption by Islamic Banks from Saudi Arabia, the United Arab Emirates and Qatar is very likely, adding:

“Currently, a number of Islamic Banks in the Middle East are evaluating the advantages of using blockchain and security tokens for their financial products. However, it’s too early to say what type of financial products they will adopt based on blockchain and cryptocurrencies.”

Shariah approval will hasten adoption

It’s important to note that the approval and audit of respected Islamic scholars remains an integral part of any process related to the launch of a Sharia-compliant digital asset. As a result, platforms/services that allow to create rulesets, as well as streamlined auditing protocols for Shariah boards, will help facilitate the acceptance of crypto-related products within the Muslim world in a much more hassle-free manner. 

In this regard, Nabil Issa, a partner at King & Spalding — a white-shoe international corporate law firm — told Cointelegraph that automatically enforced sophisticated policies are essential for digital instruments and help financial services providers and their lawyers to work with Shariah scholars to structure compliant digital assets.

And while the stringent guidelines presented by Shariah law may have an influence on potential investors who may not be willing to enter this space due to these demands, a fully-compliant product will be more marketable than a conventional fund in Malaysia, as well as the Gulf Cooperation Council region. Issa added:

“In general, nothing prevents a non-Muslim investor from investing in a Shariah-compliant product, therefore, forming and ensuring the digital asset is Shariah-compliant opens such to a wider pool of potential participants. In fact, many potential non-Muslim investors appreciate that such investments are being made ethically and will not involve high-risk financial products. Such are often re-termed as ‘ethical’ financial products.”

Lastly, careful consideration also needs to be given to target investment companies that may be deriving a part of their income from haram activities, such as supermarkets, airlines, hotels and restaurants. Issa pointed out that it is generally accepted that any haram income of a noncompliant target company that does not exceed 5% of its overall gross income can be classified as marginal or incidental.

The Muslim world should get ready

Contrary to some popular misconceptions surrounding Islam and its incompatibility with crypto, it is worth noting that all four Sunni schools have fully recognized nonphysical items as valid property and, therefore, permissible to trade. Intellectual property and trademarks are examples of non-physical property. What’s more, any valid type of property can also be traded under Shariah. Matthew Martin, the founder and CEO of Blossom Finance — a blockchain-based securitization and investment platform utilizing Islamic finance principles — told Cointelegraph:

“Shariah scholars such as Mufti Faraz Adam and Mufti Muhammad Abu Bakar have noted that cryptocurrencies generally meet the definition of money under Shariah, and Dr. Mohamed Daud Bakr notes that cryptocurrencies meet most but perhaps not all requirements for Islamic currency. Given this, it’s advisable for Muslims to only trade on a cash basis.”

Also, while crypto trading may soon start to gain mainstream traction within the Islamic world, the vast majority of digital asset derivatives are not Shariah-compliant and thus will (most likely) not be available in these regions. Martin explained: “I can’t imagine any crypto-asset derivative being Shariah-compliant unless you had, for example, trade receivables in that asset, and you needed to hedge against the risk of volatility in the asset’s price.”

Malaysian decision a game-changer?

On the subject of how Malaysia’s recent move to legalize digital asset trading could impact the rest of the Islamic world, Kelvyn Chuah, a co-founder and managing director of SINEGY —a regulated Malaysian digital asset exchange — told Cointelegraph that the latest decision can have implications on the issuance of digital assets that are guided by the principles of Islamic finance, adding: “This opportunity can put Malaysia on the world map for creating an environment where innovation can flourish, yet be harmoniously guided by deep ethical values.”

A similar sentiment is also shared by Behboudi, who believes that in the near future, Shariah experts across every Muslim nation will be able to formulate a comfortable set of rules to resolve any unknown issues regarding crypto to make the novel asset class fully available to the global Muslim community. In fact, he pointed out that a number of countries like Iran, Turkey, and UAE already have clear Shariah rules on how cryptocurrencies should be governed.

Lastly, Martin believes that due to the simple fact that Shariah law is primarily concerned with the generation and preservation of wealth, digital tokens present Islamic governments with the promise of channeling capital to productive sectors, such as crypto, all while being rooted in principles like transparency and accountability.

Some areas tied with crypto still need more consideration

While digital asset trading may be compatible with a vast majority of the Shariah guidelines in existence today, as far as the buying and selling of digital asset derivatives go, things can become much more complicated — especially since a vast majority of these offerings are highly speculative in nature and thus incompatible with the basic tenets of Islamic finance. On the subject, Issa noted:

“In many cases, derivatives are not Shariah-compliant if they involve gharar, a high degree of risk or uncertainty. We note, however, that there are Shariah-compliant derivatives that operate by limiting the level of risk. Thus, any digital asset will need to meet the same requirement as a non-digital asset.”

Lastly, Jorge Sebastiao, a Dubai-based blockchain advisor and the former chief technology officer at Huawei, believes that for now, the Islamic world should concentrate on enjoying the several Shariah-compliant digital assets that are available to them, such as those backed by real estate and precious metals, rather than focus on the derivatives market — an option that can always be explored more closely in the months or years to come. He added: “The Shariah community is quite conservative. So, I see the creation of such derivatives markets at a much later date, certainly not immediately.”

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