In the current whirlpool of speculation at Digital Asset Exchanges, speculative cryptos will drive out non-speculative ones from circulation.

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Paper money was introduced almost four Centuries after the birth of the first Islamic state in Madinah. I presume the Islamic world must have witnessed numerous scholarly debates on its role in the Islamic economy prior to its adoption. I had the privilege of following one such event, perhaps many Centuries later, the Fourth Fiqh Seminar in India, where over a hundred Muftis from across the country had assembled to deliberate on the “Role and status of paper currency in Islam”. As a student of economics, I was puzzled why such a discussion was deemed necessary in the first place. Isn’t it basic high school economics after all – the mnemonic rhyme: “Money is a matter of functions four: a medium, a unit, a standard and a store.” Anything that performs as a medium of exchange, a unit of account, a standard of deferred payment and a store of value is money, we were taught. And here was an assembly of scores of revered scholars who were debating about a basic question:

In the Islamic state, during the times of Prophet pbuh, gold and silver performed the role of currencies. During contemporary times, paper currencies have effectively replaced gold and silver as money. Therefore, will the rules of Shariah that govern money or currency in Islam apply to paper currencies?

My first reaction to this was of bewilderment. Why on earth this even constitutes the theme of a seminar? What a wasteful application of human minds and efforts, this is? Soon I had the answer. As I started to follow the papers presented at the seminar exerting some additional efforts to translate the Urdu-language papers into English, I saw the reason. I realized that notwithstanding the popularity or universality of acceptance of an action or solution, it must be subjected to the tests of Shariah in the light of its most fundamental and basic tenets to be deemed acceptable. I went on to summarize the key points, raised some additional issues that followed from the discussions, seeking to address them in the light of economic sense. A complete research document spanning over twelve thousand words was ready. It later turned out to be among my most cited publications in the Journal of the Islamic Economics Institute, King Abdulaziz University[1]. It also gave a decisive turn to my career and permanently pushed me into the domain of Islamic economics.

Now after two decades, I am intrigued by the excitement all around about a new generation of currencies called cryptos or digital currencies. These herald the era of digital economies and decentralized finance. I feel we must once again revert to the original tests of Shariah and reflect upon the rationale underlying the rules of transaction in money before we rush to issue or accept fatwas on their acceptability or otherwise in Muslim societies.

Fiqh of Currencies

The most fundamental source of the rules of fiqh regarding currency transactions is the following hadith:

The Prophet (peace be upon him) said, “Sell gold in exchange of equivalent gold, sell silver in exchange of equivalent silver, sell dates in exchange of equivalent dates, sell wheat in exchange of equivalent wheat, sell salt in exchange of equivalent salt, sell barley in exchange of equivalent barley, but if a person transacts in excess, it will be usury (riba). However, sell gold for silver anyway you please on the condition it is hand-to-hand (spot) and sell barley for date anyway you please on the condition it is hand-to-hand (spot).”[2]

Scholars classify the six commodities cited in the hadith into two broad categories. The first category includes gold and silver, which primarily served as money or currency in the Islamic state. The second category includes basic food items. Within these categories:

  • when exchange takes place between commodities with same genus (gold for gold or silver for silver for silver, or dates for dates etc.) the rate of exchange cannot differ from one and the transaction has to be settled on spot; and
  • when exchange takes place between commodities with of different genus (gold for silver, or wheat for dates etc.) the rate of exchange can differ from one and the transaction has to be settled on spot.

Scholars vary in their analysis of the rationale behind rule #1. I am inclined towards the view that Shariah discourages barter trade – especially in currencies and basic food items – and emphasizes the need to use the market mechanism for exchange to take place in the interest of proper price discovery.

The rationale behind rule #2 can be understood in the context of “interplay” of the evils of interest (riba) and speculation that is akin to gambling (maysir and qimar) in contemporary financial markets. It is not hard to see that deferment in settlement of a transaction either by one party or both is a precondition for any interest-based or speculation-based transaction to materialize. Shariah negates the possibility of both types of evils ab initio by insisting on “spot settlement” in transactions relating to currencies and basic food items considering their utmost importance in any economy.  For other commodities, of course, Shariah permits deferment in exchange (by buyer or seller or both) under specific conditions to avoid the forbidden elements.

It is not hard to see that deferment in settlement of a transaction either by one party or both is a precondition for any interest-based or speculation-based transaction to materialize.

Further, a kind of consensus exists among Islamic scholars that the rule #2 applies not just to gold and silver, but also to anything, such as, paper money or plastic money or electronic money that performs their functions, which is being in the nature of thaman or medium of exchange or money. The transaction in such objects is called bai-sarf.

A Chicken-Egg Problem

In the light of the above, it would be interesting to bring to the table for discussion the rules governing digital currencies as formulated by the Shariah Advisory Council of SC (SAC) of the Securities Exchange Commission of Malaysia. The SAC recognizes digital currency as mal from Shariah perspective and distinguishes between (i) digital currency that is backed by technology without any underlying asset and (ii) that is backed by either gold, silver or any other currency or other ribawi items (from the list six commodities as above). It views the former as non-ribawi or not susceptible to riba. By implication, transaction in such currencies does not require settlement on the spot. Deferment is permitted. The SAC invokes the rules of bai-sarf for the latter type of digital currencies.

From a fiqhi perspective, the type (i) currencies may be treated similar to fals or currencies made out of inferior metals. Such currencies with limited acceptance as medium of exchange or those used in small-denomination transactions are not subject to the principles of bai al-sarf. In my paper, I have discussed in detail the views of scholars, especially from the Hanafite school of jurisprudence, that permit bai-salam in fals. This line of argument is used at times to treat paper currencies at par with fals and accord permissibility to bai-salam in currencies.

In essence, except for digital currencies backed by gold or silver or other currencies (e.g. stable coins), all other digital currencies are deemed NOT be in the nature of money. This may be because it defines digital currencies in a particular way. A digital currency  (a) is traded in a place or on a facility where offers to sell, purchase, or exchange of, the digital currency are regularly made or accepted; (b) a person expects a return in any form from the trading, conversion or redemption of the digital currency or the appreciation in the value of the digital currency; (c) is not issued or guaranteed by any government body or central banks as may be specified by the Commission; and (d) is prescribed as securities for the purposes of the securities laws. The SAC seems to explicitly recognize the speculative potential of such currencies (as in pt.b above) and creates an enabling environment for the same, clubbing the same with securities as any other digital asset.  

This leads one to wonder if there is a chicken-egg problem here. The circular reasoning may appear as follows:

#1. A digital currency being unstable (due to rampant speculation leading to highly volatile values) serves as a poor measuring rod or unit of account and hence, as a poor medium of exchange and a poor store of value. Since it does not serve the functions of money well, it cannot be deemed as money.

#2. A digital currency is not quite in the nature of money; hence deferment in settlement is permitted and the same opens room for rampant speculation and wild volatility.

The government agencies – central banks, securities commissions and what-have-you – may have an interest in perpetuating the status quo; of volatile and speculative markets in digital currencies that do not have the backing of the government. The “anarchist” dimension associated with an open, border-less and permission-less environment is understandably unpalatable to the sovereign. It, however, suits the interests of the speculators and gamblers well. The vultures are happy. It is now common knowledge that markets in digital currencies are a haven for manipulators. Indeed, there are no full-proof mechanisms against the widely suspected practice during Initial Coin Offerings (ICOs) of earmarking a part of the funds raised just for playing the after-market and to artificially jack up the values.

Gresham’s Law 2.0

Meanwhile, one is perhaps witnessing the rewriting of the old school Gresham’s law. The law simply states that bad money drives out good money from circulation. More exactly, if coins containing metal of different value have the same value as legal tender, the coins composed of the cheaper metal will be used for payment, while those made of more expensive metal will be hoarded or exported and thus tend to disappear from circulation.

In the world of cryptos or digital currencies, currently dominated entirely by speculators and gamblers, purely speculative cryptos will drive out non-speculative cryptos from circulation. There is some anecdotal evidence that this is already happening. Some of the ICOs performing poorly in the after-market may indeed be backed by great projects. Arguably, ICOs trade low and projects fail for a variety of reasons. If they do so, because they are inextricably linked to real sectors e.g. agriculture, energy, healthcare and what-have-you, and hence, not exciting enough for speculators, it would be unfortunate indeed. I look forward to discussing a few such cases in forthcoming blogs.

(To be continued)


[1]Financial Options in Islamic Contracts: Potential Tools for Risk Management” journal of King Abdulaziz University-Islamic Economics · January 1999. The original title of the paper was “Currency Markets: An Islamic Evaluation”.

[2] Hadith narrated by Ubadah ibn as-Samit; Sahih Muslim, Book 9, No.3798

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