Reconciling Islamic Finance, Microcredit, and Bitcoin

Recently I went down a rabbit hole by purchasing Islamic Finance for Dummies. For the uninitiated, it is against Islamic law to participate in some financial transactions, particularly:

  • charging interest
  • risky, speculative transactions (e.g., paying for an unbuilt house)
  • participating in businesses against Islamic law (gambling, alcohol, pork)

Most banks in the world fail at these criteria, as most wouldn’t think twice about offering loans to a grocery store which carries pork. So there are Islamic banks, insurance agencies, and other institutions. It’s important to note that this separation has evolved over time: the restrictions are similar to Old Testament rules which were followed by Christians until the 1500s (read the wiki article on usury). Islamic financial restrictions were loose for centuries until a resurgence in the 1970s and again after its relative immunity from the 2008 financial crisis. At this point I imagine that adherence to Islamic finance varies from place to place.

Implications

A few years ago I read Startup Rising: The Entrepreneurial Revolution Remaking the Middle East, and entrepreneurs typically pointed to two cultural blocks: wasta (‘connections’) mattering more than good ideas, and cash-on-delivery.

An online service in many parts of the Middle East is expected to ship an order and have the recipient decide whether to pay once it arrives. Considering how much of retail shopping is based on impulse purchases, and returning items is much easier and more common, many online shops are hurt by this.

Islamic finance rules prevent existing microcredit initiatives from taking root in some communities. In 2015 the Bill and Melinda Gates Foundation produced a report (PDF) on Islam and microcredit/microfinance:

Market surveys by financial institutions and other reports on Islamic microfinance consistently argue that poor Muslims in particular “[show] significant rates of rejection of traditional microloans.”

The report, researched and written by Bridget Kustin, goes on to cover Islamic banks experimenting with microcredit in three countries: Bangladesh, Indonesia, and Pakistan. In one Bangla organization:

Each microfinance collective is comprised of 10–40 clients subdivided into two to eight groups of five members each, a model borrowed from the Grameen Bank, whereby group members bear liability for each other’s weekly repayments. Unlike Grameen, however, IBBL bases its group liability model on a “Group Approach” in accordance with Qur’anic guidance. As program materials explain, “Allah loves those ‘who conduct their affairs by mutual consultation’ (AlQur’an 42:38).”

2018 Update: I’m taking an Islamic Microfinance course to learn more opportunities for cryptocurrency in this field. If you are interested in this space, please email me at ndoiron@mapmeld.com

Alternative Investment

Islamic banks may be designed around religious laws, but they also need to be profitable, value-generating businesses. Entrepreneurs want funding. How do they do it?

One example is LaunchGood — a crowdfunding site for Muslims doing good deeds around the world. The site has been certified for Islamic finance, they vet their campaigns, and for Ramadan this year they promote one project each day. I donated to a few campaigns for humanitarian and linguistics causes. At checkout, it asks you to also cover fee-processing expenses, but reminds you not to include them in your zakat.

Often Islamic banks may purchase specific assets for an entrepreneur and begin a leasing / rent-to-own process. The Gates Foundation microfinance report notes:

bai-muajjal and murabaha require that money given toward the purchase of an asset be used exclusively for that asset. In this sense, Islamic microfinance places more constraints on the daily economic decision-making of the poor…

For larger-scale projects, it is typical for a partnership to be formed where the bank receives a share of profits rather than interest. The bank aims to find profitable businesses and make sure that they succeed, rather than pushing them to pay back money over time regardless of success or failure. This may lead to banks being conservative, or aiming for quickly profitable or very secure businesses. There are also banks who will lend money for a fee, which may seem similar to interest. Complaints over a 10% fee produced this comment recorded by the Gates Foundation report:

There is a difference between a halal chicken and a haram chicken. Both are chicken, they look and taste the same, but Muslims can only eat one.

tl;dr — the sourcing, investing, and intent of an Islamic financial contract are trusted, and the final cost is fixed, so it should be judged on its social equity and not by summing up repayments on a loan and Islamic funds.

Can Muslims use digital currency?

This is an interesting question. As best I can tell (tl;dr) most people believe that Bitcoin is compliant with Islamic finance, but existing analysis is published by Bitcoin proponents and entrepreneurs with vested interest.

Here’s Davi Barker’s post, the earliest analysis I could find, in January 2013:

Imran Hosein identifies six traits common to all of these that amount to a definition of money in Islam.
- Money is either precious metals or food.
- Money is abundant and freely available.
- Money is durable and does not spoil or corrode.
- Money has intrinsic value.
- Money exists in creation and is made valuable by God.
- Money functions as a medium exchange.

The first point is a problem for electronic currency, not anticipated by Islamic scholars. Barker continues to read about other non-metallic currencies from Hosein’s text, and concludes:

His objection to sand and paper is not that they are not metal or food, but that they have no intrinsic value… [value must be] determined by supply and demand, and not artificially assigned by central planners.

Also in 2013, CryptoInsider reports that Professor Ahamed Kameel Mydin Meera warned that a digital currency must be backed by physical currency:

For a digital currency to be accepted by Islamic Finance, it needs to have a measure of value, necessarily the measure of value has to be a monetary commodity. You have to put a standard weight on paper notes or electronic currencies to be accepted.

By “standard weight” the professor is referring to his own proposal, the gold dinar strongly based on gold coins that were minted early in Islamic history. The electronic version works like this:

Gold-based interest-free electronic credit is the most desirable form of money (using cards, internet, mobile phones, computers etc)…
Such system is not akin to fractional reserve banking because this system does not create new money and does not involve the transfer of credits for payment purposes…
Also the system permits real-time electronic audits.

If Bitcoin really is banned, then I can understand this line of thought, but otherwise it is not technically or financially superior to use digital gold notes issued by central banks.

[please note: I do not personally endorse the political and economic views of Davi Barker, Sheikh Imran Hosein, or Professor Meera, but use their words here as early sources on the subject]

Is Bitcoin actually accepted in Islamic countries?

The main projects which I think of in this space are:

  • BitOasis — popular exchange across the Middle East, described here in a UAE newspaper article
  • Code to Inspire — coding school for girls in Afghanistan, which has at times promoted Bitcoin locally / received Bitcoin donations
  • Dubai Blockchain Strategy — a technology initiative recent launched by Dubai’s Crown Prince
  • Blossom Finance — crowdfunded microcredit in Indonesia

Research on Coin ATM Radar shows one Bitcoin ATM was installed in Jubail, Saudi Arabia, and a 2014 Reddit post talks about a Meetup group (with many agreeing that it is compliant with Islamic law). If someone could install a public ATM in Saudi Arabic, I feel that this been given a stamp of approval, and not just flying under the radar / limited to lenient countries.

Updated December 2017: Turkey’s Directorate of Religious Affairs appears to have rejected Bitcoin as un-Islamic.

And by a religious official in Egypt:

Counterpoints from ForexNewsNow:

Isn’t Bitcoin speculative and involved in un-Islamic businesses?

I wouldn’t call Bitcoin stable, but that only relates to its performance over time / investment potential. It is not the vaguely unbuilt house used in my Islamic Finance book. And there are stock exchanges for Islamic companies. So Bitcoin’s Muslim proponents are comfortable with it.

Bitcoin is notorious for drug trade (Silk Road) and ransomware (WannaCry). This has made a strong impression on the public, and that is definitely noticed in discussions about Islamic finance and Bitcoin.

If Bitcoin is tainted, couldn’t the same argument easily be made for dollars, or virtually any currency in public circulation? There is no guarantee that a currency hasn’t been used for drugs or gambling unless a bank can monitor each transaction (which may be possible with the blockchain), and even then the bank could be deceived.

It is possible but not advisable for programmers to fork Bitcoin, or to do an Initial Coin Offering (ICO) within Ethereum, and support that as an Islamic currency. This same idea has drawn many to the Bitcoin world, including Native American tribes (Mazacoin), Hawai`i independence activists (Alohacoin), every Icelandic citizen (Auroracoin), and alternative browser Brave (Basic Attention Coin). If you haven’t heard of these currencies, you might want to research their failures. An early cryptocurrency is fairly small and obscure. Altcoin speculators can pump and dump the coins on various markets (Brave), or the creators may pre-mine the currency for their own benefit, or a 51% attack / fork / slow verification times can pull you under (Auroracoin). As soon as an altcoin runs into trouble, the exchanges pull out and make it difficult for users to move money in and out, causing a panic which lowers the price, discourages miners and investors, and gets it removed from other exchanges.
Unless you have a strong market ready to start using and defending your currency, I cannot support this route.

2018 Update: Gold-Backed Cryptocurrencies

OneGram and HelloGold are two halal cryptocurrency startups which back their coins with gold, to assure users that it is not a speculative currency.

Smart Contracts and Islamic Finance

There is an interesting project on GitHub describing how one might set up an Islamic bank in countries with only small Muslim minorities, by using an Ethereum smart contract as the bank. The bank would have minimal fees and no need for interest payments, because it is run autonomously. The repo’s creator is in Japan, and says that Japanese banking laws restrict practices required by traditional Islamic finance.

It would be impossible for the bank to guarantee refunds or repayment from a cryptocurrency account, so this system proposes creating a strong ID and community trust system to vet potential lending agreements.

You could also use a smart contract to guarantee profit-sharing between the bank and a funded business in a proven, trustable way. It works unless the entrepreneur starts accepting payments directly instead of putting them into the contract, but fraud is achievable and prosecutable in any industry.

What about Bitcoin and ISIL ?

You may have seen stories in 2015 about how ISIL funded itself, including the possibility of cryptocurrency (mostly Bitcoin).

Jerry Brito of the Coin Center told Congress this week that there was “no more than anecdotal evidence” of this taking place. As in other criminal enterprises, the traceability of the Bitcoin blockchain is seen as a liability, and criminals tend to stick to more traditional forms of money laundering. That said, I would be wary of sketchy people backing altcoins (as they are tracked less, or like Zcash, may be possible to use without being tracked).

Conclusions

I want to dig deeper into Islamic finance… it appears that a digital option here (based on gold or paper currency, or on cryptocurrencies) could attract interest from wealthy Muslims, and provide essentials to the poor. If you ignore this system, a business may have trouble expanding globally, or a charity could shut out many of the people that it wishes to protect.

Defining these applications in open source code and smart contracts would make it easier for Islamic institutions which understand their business and requirements to evaluate their options. I wonder if a less risky smart contract could be developed as an accounting and financing tool for a ‘serverless’ bank. This would be a small team using their standard national currency, but with record-keeping and overhead occurring automatically in the blockchain. This bank and entrepreneur would report transactions and get their financial records from the contract. If they found a breach in the contract, they would be able to show all of their agreements and transactions in court.

At the end of the day, one’s religion and beliefs are their own personal choice. There are scholars with strong opinions on either side, so I am sure that you could research which ones appear credible, or find a compromise in using Bitcoin/cryptocurrency for trustworthy purposes.