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Halal Crypto: could blockchain be a boost for Shariah-compliant finance?

Hamza Redzuan, Research Analyst, Qatar Centre for Global Banking and Finance

With the global Muslim population exceeding 1.8 billion, and increased demand for investment opportunities aligned with religious principles and community ethics and values, the global Islamic finance market is set to amount to 6.67 trillion U.S. dollars by 2027. Yet the substantial opportunity that this represents in the cryptocurrency space is still largely unexplored.

02 September 2024

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While many traditional finance products are considered haram (non-permissible) to Muslims, a range of financial products enable Muslims to invest in accordance with Shariah (Islamic religious principles). These products take into account key principles such as the prohibition of exploitative actions, the promotion of honesty, and zakat, the requirement to give to charity.

Perhaps the best-known example of an Islamic financial product is sukuk, a financial certificate similar to a bond in Western finance. The traditional Western interest-paying bond structure with pre-determined payments, however, is not permissible in Islamic finance; the bond payments are considered to be riba (excessive gain – a form of exploitation) as the bond-holder avoids direct exposure to enterprise risk. Instead, sukuks are structured so that both the lender and borrower share the enterprise’s profits and losses, which means that investors can gain higher yields if the underlying asset appreciates, whereas conventional bondholders only receive returns based on the security’s original value.

Some cryptocurrencies are considered to be Shariah-compliant, but crypto has generally elicited mixed views in the Islamic world. Some scholars rule that investing in crypto is halal as long as the underlying project is halal, while others consider the whole category to be haram, as crypto characteristics, such as valuation based on market fluctuation and its use in gambling, are considered un-Islamic. For example, Indonesia's National Ulema Council prohibits crypto due to the “uncertainty, wagering and harm” surrounding it, issuing a fatwa (formal ruling or interpretation on a point of Islamic law given by a qualified legal scholar) in October 2021.

HelloGold (a gold-backed cryptocurrency originating in Malaysia) and Islamic Coin (an ethics-focused cryptocurrency) which operates on the HAQQ blockchain are examples of innovations aimed at addressing the concerns that some Islamic scholars have with cryptocurrencies generally.

Islamic Coin was privately financed by blockchain and fintech entrepreneurs to create an ethical and sharia-compliant financial service, while the HAQQ blockchain itself has been integrated with leading private and government-affiliated services in the UAE. Furthermore, establishing a Sharia board comprising five of the region’s top experts and 40 banks, including well-known institutions like Standard Chartered, Abu Dhabi Islamic Bank, and Dubai Islamic Bank enables Islamic Coin to accurately assess project compliance with Islamic principles.

As blockchain technology is distinct from cryptocurrencies, it has a much wider potential application in the halal investment space. Sukuk can be tokenized and considered Sharia-compliant as being recorded on the blockchain is equated to greater transparency, helping buyers to assess issuer credibility and make informed investment choices. Furthermore, blockchain-based assets benefit from higher security as all transactions, profits and real-time information are communicated to investors.

Previously, the development of Sharia-compliant bonds, achieved through structures such as risk-sharing for lenders and linking Sukuk repayment to underlying asset performance, has enabled Muslim investors to participate in this asset class. For tokenized bonds, there are various modifications potential workarounds that can be implemented for the same purpose:

Emphasising Zakat principles such as on the HAQQ blockchain network where the fact that 10% of new coins go to Evergreen DAO for Islamic charity helps to avoid interest and unethical projects.
Backing tokenized bonds with halal assets (e.g. gold or real estate) and using secure, transparent blockchains with transactions recorded & verified by a network of nodes.
Adhering to general ethical principles such as fairness, transparency and social responsibility ensures the tokens are not used for illegal or unethical activities, like money laundering. A team of experts in Islamic finance and blockchain must also be brought in to ensure compliance with Islamic law.
The transaction needs to be centred around promoting economic activity rather than making money out of money.

Smart contracts

As well as using blockchain to enable transparency and cryptography to safeguard individual transactions, ensuring that they are ethical and follow Sharia guidelines, Islamic Coin has made innovative use of smart contracts. Smart contracts are similar to regular contracts, but with terms established as code on the blockchain which cannot be changed. This increases transparency, security and trust and aligns with Islamic law’s emphasis on fulfilling contracts as mentioned in the Quran.

For example, Blossom Finance's Smart Sukuk links the cryptocurrency ecosystem with the real economy by using a contract-based Sukuk to invest in small and medium-sized enterprises (MSMEs) in Indonesia, increasing investment and financial inclusion. Smart contracts and blockchain could also enhance the performance of certain aspects such as zakat (charity), by introducing transparency, automation, and reducing time costs. Raheb (2020) devised a funding model that integrates blockchain and smart contracts with zakat management, aiming to identify potential zakat payers thus improving overall zakat collection.

The future for ‘halal crypto’

So what does the future hold for halal crypto?

Halal crypto” is not limited to Muslim-majority countries, or indeed buyers (for example, over half of the Islamic Coin’s private sales involved non-Muslim participants, presumably attracted by the product’s ethics) but globally it has yet to become a mainstream, fully financially regulated product. In many countries, financial regulators’ oversight of crypto assets of any kind is restricted to adherence to anti-money laundering requirements. By contrast, in Malaysia, halal crypto is regulated by the Securities Commission (SC) and companies raising funds in this way must conduct an Initial Exchange Offering on an approved digital asset exchange platform. But while in more crypto-friendly regulatory regimes there is a precedent for making halal crypto a more mainstream, regulated asset class, there is still much work to be done to ensure investor confidence in their compliance with Islamic law.

We have seen that smart contracts and the blockchain can help digitised sukuk to align with Islamic values through contract fulfilment, transparency and fairness, but a council of scholars well-versed to develop Sharia-compliance guidelines for tokenized bonds would still be greatly beneficial. In the cryptocurrency space, the debate over whether such a product can be deemed halal continues.

In many countries – both Muslim and non-Muslim – the interaction of crypto with existing regulatory frameworks has been complicated and often controversial. Anti-money-laundering and investor protection laws alone make the spread of crypto difficult and the requirement of Sharia compliance adds more nuance. Nevertheless, important progress is being made. For example, in Malaysia, halal crypto is regulated by the Securities Commission and companies raising funds in this way must conduct an Initial Exchange Offering on an approved digital asset exchange platform.

Despite these ongoing discussions, however, with the rise of Islamic cryptocurrency exchanges such as HelloGold and Islamic Coin, there is now certainly more guidance and regulation for Muslims looking to invest in crypto assets in a way that aligns with their principles.

References

Statista: Worldwide value of Islamic Finance assets

King's Business Review: Sukuk: the halal bond

Saturna Capital: What makes Sukuk Halal?

Reuters: Abu Dhabi's Al Hilal Bank uses blockchain to sell sukuk in secondary market

Reuters: Saudi-based ICD eyes blockchain-based tool for Islamic banks

Press release: Islamic Coin and Haqq Blockchain ink major agreements in medical care, travel, wellness and immigration services

Coin Telegraph: IMF examines CBDC design in context of Islamic Banking, finds some risks magnified

Freeman Law: Malaysia and Cryptocurrency

Arabian Business: Islamic Coin: World’s first Sharia compliant cryptocurrency to launch in May, co-founder reveals

Nasdaq.com: How Cryptocurrency Aligns with the Principles of Islamic Banking and Finance

Stobox: Why security tokens are Shariah-compliant crypto instruments