Navigating Cryptocurrencies and Blockchain from a Sharia and Technical Standpoint

Amidst the accelerating technological transformations the world is witnessing, the concept of digital cryptocurrencies and blockchain technology stands out as a driving force reshaping the global financial system. These concepts are no longer marginal trends; they have become an influential reality, raising questions about the future of financial transactions, the role of central banks, and even the concept of trust in the digital economy.

In this article, we review the latest developments in this world and their potential impact on the global financial system, focusing on the associated regulatory and sharia challenges.

Evolution of the Digital Currency World

Recent years have seen tremendous developments in the field of digital cryptocurrencies. Following the strong emergence of Bitcoin in 2009 (as the first cryptocurrency), thousands of other digital currencies such as Ethereum and Ripple have appeared, each with its characteristics and uses. It is no longer limited to merely a means of digital payment but has extended to include new concepts such as:

• Decentralized Finance (DeFi): This system aims to build open and transparent alternatives to traditional financial services, allowing access to financial services (such as loans or trading) without the need for a bank or an intermediary.
• Non-Fungible Tokens (NFTs): These are digital tokens used to prove ownership of digital content, such as a piece of art or a music clip, and they have revolutionized the ownership of digital and artistic assets.
• Central Bank Digital Currencies (CBDCs): These are attempts by governments to develop digital versions of their official currencies, such as the digital yuan in China or the digital euro in Europe, representing official recognition of the potential of this technology.

Sharia Perspective on Digital Currencies

With the expansion of digital currency types, sharia questions about their legitimacy intertwine, as the ruling differs according to the nature of each. For traditional cryptocurrencies like Bitcoin, jurisprudential debate revolves around considering it legitimate wealth and the resulting rulings. Some jurists permit dealing with it if its value stabilizes and it becomes a medium of exchange, while others prohibit it due to its lack of currency characteristics and monetary functions, in addition to its involvement in excessive gharar (uncertainty), jahalah (ignorance), and high risks that may amount to gambling (maysir).

As for Decentralized Finance (DeFi), it can open horizons for developing Sharia-compliant financial solutions, especially if its applications are built on partnership and mudarabah contracts, away from usurious interest and prohibited practices. Similarly, for Non-Fungible Tokens (NFTs), their Sharia ruling is closely linked to the content they represent. Dealing with them is permissible if the content is lawful and does not violate Sharia and represents real ownership, and it is prohibited if the content is forbidden or if they are merely a means of gambling.

In contrast, Central Bank Digital Currencies (CBDCs) appear closer to Sharia acceptance because they are state-backed digital currencies subject to regulation, which reduces potential gharar and jahalah factors.

Blockchain Technology: The Foundation of the Digital Revolution

Blockchain technology is the core of cryptocurrencies. It is simply a decentralized database or digital ledger based on a chain of "blocks" containing data and transactions that are verified, encrypted, and permanently added to a continuous and tamper-proof chain, much like a global ledger that uses the highest level of encryption. Once a transaction is recorded in a block, it becomes an integral part of the chain, making it difficult to manipulate. What distinguishes this technology is:

• Decentralization: The decentralized nature of digital currencies weakens the role of traditional financial institutions as intermediaries, reducing costs and increasing efficiency and speed.
• Security: Digital currencies use advanced encryption technologies to ensure the security and anonymity of transactions.
• Transparency: Digital currency transaction records are stored on a publicly available blockchain, which increases transaction transparency.

The use of blockchain is no longer limited to digital currencies; it has extended to various applications in many fields, such as supply chain management, intellectual property protection, electronic voting, and healthcare, indicating the enormous potential of this technology to change many industries.

From a Sharia perspective, there is no problem with blockchain technology itself as a technology for recording, storing, and securing data. It is a neutral tool, and the decentralization and transparency it provides may align with Sharia principles in contracts and transactions that require clarity and prevention of gharar, especially if used in permissible applications and adhering to controls.

Potential Impact on the Global Financial System

The rise of cryptocurrencies and blockchain technology carries transformative potential for the global financial system. These technologies can provide more efficient and inclusive alternatives to traditional financial services, such as providing financial services without banks, especially for underserved populations, as anyone can access financial services directly from their phone. They can also facilitate cross-border payments, reduce their costs, improve execution speed, and enhance transparency and security in financial transactions, given that all transactions are recorded and traceable.

Additionally, decentralized finance can restructure some aspects of the financial system and innovate new financial instruments through lending and investment platforms built on blockchain.

Some countries have begun to react to these changes, including some Arab countries that are considering launching their own digital currencies and attempting to regulate them instead of resisting them, by adopting central bank digital currencies to protect their economies and citizens, and as a means of controlling the digital economy.

Regulatory, Security, and Sharia Challenges

Despite the promising potential, cryptocurrencies and blockchain technology face significant challenges, especially on the regulatory and security fronts. The regulatory framework for these technologies is still evolving in most countries worldwide, creating uncertainty and opening the door to risks. This is in addition to the absence of laws; many countries have not yet enacted laws regulating the use of digital currencies, protecting investors, or preventing the use of these technologies in illegal activities such as money laundering, without stifling innovation.

On the security front, despite the strength of blockchain technology, digital currencies remain vulnerable to hacking and cyberattacks. Also, losing a private key or falling victim to fraud can lead to complete loss of funds. Therefore, enhancing cybersecurity and developing effective user protection mechanisms is a top priority.

On the Sharia side, the lack of clear regulation for cryptocurrencies raises significant Sharia concerns, especially regarding gharar and unjustified risks. Sharp price fluctuations, the absence of a regulatory body, and exposure to fraud all make investing in them fraught with risks that may reach the point of prohibition in some cases. Furthermore, their potential use in money laundering and terrorist financing makes them subject to Sharia prohibition, as Sharia prohibits anything that leads to corruption or harms society.

Arab Countries' Stance on Cryptocurrencies

The stances of Arab countries have varied significantly on the regulatory front, reflecting the different Sharia fatwas issued by religious bodies. While some countries, such as Saudi Arabia and Egypt, have imposed strict restrictions or bans on cryptocurrencies due to their Sharia risks of gharar and jahalah, and their potential risks to financial stability and investor security, other countries like the UAE and Bahrain have begun exploring regulatory frameworks for cryptocurrencies and blockchain technology based on permissible opinions, and even working to adopt them in specific areas. This reflects a divergence in visions and a cautious approach to dealing with these technologies.

Cryptocurrencies and blockchain technology represent a qualitative leap in the form of the global financial system, between promises of facilitating transactions and enhancing financial inclusion, and concerns related to regulation and security. Dealing with them from a Sharia perspective requires extreme caution. Individuals and financial institutions must verify the Sharia aspects of each application and avoid anything that involves gharar or leads to what is prohibited. Establishing a clear and strict regulatory framework, consistent with the principles of Islamic Sharia, will help utilize these technologies to build a more just and transparent financial system.

________________________

(1) OECD (2022). Crypto-Assets: Key developments, regulatory concerns and responses.  Available from: https://www.europarl.europa.eu/RegData/etudes/STUD/2020/648779/IPOL_STU(2020)648779_EN.pdf

(2) بيومي، عبد الناصر حمدان، (بدون تاريخ)، العملات الرقمية المشفرة في ضوء عقود المعاملات الشرعية: الحكم الشرعي وتحرير محل النزاع. منتدى البركة للاقتصاد الإسلامي. تم الاسترجاع من:  https://forum.albaraka.site/العملات-الرقمية-المشفرة-في-ضوء-عقود-ال-6/

(3) مرزوق، آمال. (2021). تقنية البلوكتشين وتطبيقاتها الاقتصادية. مجلة الشرق الأوسط للعلوم الإنسانية والثقافية، 1(5)، 302–312. https://www.researchgate.net/publication/367185119_tqnyt_alblwktshyn_wttbyqatha_alaqtsadyt

(4) Wang, Y. (2024). The impact of digital currencies on the financial system and the social economy. International Journal of Global Economics and Management, 4(2). Available from: https://www.researchgate.net/publication/384430735_The_Impact_of_Digital_Currencies_on_the_Financial_System_and_the_Social_Economy

(5) Schwarz, N., Chen, K., Poh, K., Jackson, G., Kao, K., Fernando, F., & Markevych, M. (2021). Virtual assets and anti-money laundering and combating the financing of terrorism (1): Some legal and practical considerations (Fintech Note No. 2021/002). International Monetary Fund. https://www.imf.org/en/Publications/fintech-notes/Issues/2021/10/01/Virtual-Assets-and-Anti-Money-Laundering-and-Combating-the-Financing-of-Terrorism-1-465899