ISLAMIC BANKING AND FINANCE

ASSIGNMENT 03

SUBMITTED BY: ROLL NO.

Bisma Zahra Gohar FA22-BAF-044

Muhammad Umair Abid FA22-BAF-106

Fiza Batool FA22-BAF-054

Syed Hammad Ali Hashmi FA22-BAF-141

Adeel Ahmed FA22-BAF-024

SUBMITTED TO:

Mam sabeen
 1. In what ways can cryptocurrencies and blockchain technology align with the ethical
investments promoted by Islamic finance, particularly in terms of transparency and
social responsibility?

Islamic finance promotes investments that are not only financially sound but also socially
responsible, transparent, and in accordance with ethical principles outlined by Sharia law. The
integration of cryptocurrencies and blockchain technology into the framework of Islamic
finance has the potential to enhance transparency, promote ethical investments, and ensure
greater social responsibility.

Transparency: A Pillar of Ethical Investments in Islamic Finance

Transparency is a fundamental value in Islamic finance, ensuring that all parties involved in a
transaction are fully aware of the terms and conditions, thus eliminating fraud and unjust
dealings. The Qur'an emphasizes honesty and fairness in trade:

“O you who have believed, do not consume one another’s wealth unjustly or send it [in
bribery] to the rulers in order that [they might aid] you [to] consume a portion of the wealth of
the people in sin, while you know [it is unlawful]” (Qur'an 2:188).

Blockchain Technology’s Role in Ensuring Transparency

Blockchain’s decentralized, immutable, and publicly accessible ledger aligns perfectly with the
Islamic principle of transparency. Every transaction recorded on a blockchain is permanent and
visible to all participants, ensuring that no fraudulent alterations or hidden fees can occur. This
structure reduces the risk of Gharar (excessive uncertainty or ambiguity), which is prohibited in
Islamic finance.

• Example: In traditional banking or investment platforms, there may be hidden fees or

unclear terms that lead to exploitation. In contrast, a cryptocurrency-based platform built
on blockchain could offer complete visibility of all fees, terms, and conditions. This
aligns with the Islamic principle of bay’ al-amanah (trustworthy sales).

Smart Contracts for Transparency in Islamic Finance

Smart contracts on blockchain can automatically execute financial agreements when pre-
defined conditions are met, without the need for intermediaries. These contracts are transparent
and immutable, meaning once they are written into the blockchain, they cannot be altered or
tampered with. This eliminates ambiguity and enhances trust between contracting parties.

• Example: A smart contract could be used for Mudarabah or Musharakah contracts,

ensuring that profits are shared as per the agreement, and no party can alter the terms
 post-agreement. All stakeholders can see how the funds are used and how profits or
losses are shared, which aligns with the Qur'an’s call for fairness and justice in business
dealings (Qur'an 16:90).

2. Social Responsibility: Encouraging Ethical and Sustainable Investments

Islamic finance is deeply concerned with social justice and the welfare of the community.
Investments must align with the maqasid al-shariah (objectives of Sharia), which include
protection of life, intellect, wealth, faith, and family. Investments in industries harmful to
society, such as gambling, alcohol, and interest-based businesses, are prohibited. Instead, Islamic
finance encourages investments that benefit society and the environment.

Cryptocurrencies Promoting Financial Inclusion

One of the core promises of cryptocurrencies is financial inclusion. By removing the need for
traditional banking intermediaries, cryptocurrencies can provide financial services to the
unbanked or underbanked populations, which aligns with the Islamic principle of Adal (justice).
In many Muslim-majority countries, where access to banking is limited, cryptocurrencies can
democratize access to capital and financial services.

• Example: A decentralized platform using blockchain could offer microfinance services

to low-income individuals, promoting financial inclusion without charging interest,
which is prohibited in Islam. Through peer-to-peer (P2P) cryptocurrency transactions,
people could gain access to funding for entrepreneurial projects that would otherwise be
inaccessible due to the prohibitive cost of traditional banking services.

Socially Responsible Investments on the Blockchain

Blockchain technology can also be used to track and verify investments in projects that align
with Islamic ethical standards. Investors can trace how their funds are being used, ensuring that
their capital supports ethical industries like renewable energy, healthcare, education, or
infrastructure.

• Example: A blockchain-based investment platform could allow users to invest in

sustainable agriculture or green energy projects, with the assurance that funds are not
diverted to non-compliant industries. This system could provide transparent audits and
records of how profits are generated and shared, aligning with Islamic values of social
responsibility and environmental stewardship.

Ensuring Sharia Compliance in Cryptocurrency Investments

a. Prohibition of Riba (Interest)

Islamic finance prohibits Riba (interest or usury), and cryptocurrencies can potentially offer
solutions that avoid interest-based transactions. Cryptocurrencies allow for peer-to-peer (P2P)
transactions without the need for interest-based lending, which is common in traditional banking
systems. Investments in cryptocurrencies can be structured around profit-and-loss sharing
(PLS) contracts, such as Musharakah or Mudarabah, where all participants share risks and
rewards.

"Allah has permitted trade and has forbidden Riba" (Qur'an 2:275).

• Example: A DeFi (Decentralized Finance) platform could issue Sukuk tokens (Islamic
bonds) on the blockchain. Investors would receive returns from the performance of the
underlying asset, such as a real estate development or a renewable energy project, rather
than through interest payments, ensuring compliance with Islamic finance principles.

b. Minimizing Gharar (Excessive Uncertainty)

Islamic finance discourages excessive speculation or uncertainty (Gharar). Cryptocurrencies are

often criticized for their volatility, which can introduce Gharar into transactions. To avoid this,
Islamic financial institutions could focus on stablecoins or asset-backed tokens that are pegged
to stable assets, such as gold or fiat currencies. These coins minimize speculation and provide
stability, making them more suitable for Sharia-compliant investments.

• Example: A gold-backed cryptocurrency could be developed for Islamic investors. By

pegging the value of the cryptocurrency to a tangible asset like gold, it reduces excessive
risk and speculation. Investors could trade and hold the currency with confidence that its
value is tied to a real-world, Sharia-compliant asset.

4. Zakat and Charity on Blockchain

In Islam, Zakat (the obligatory charity) is one of the pillars of the faith, aimed at reducing
inequality and ensuring wealth circulation. Blockchain technology can enhance the transparency
and efficiency of Zakat collection and distribution.

• Example: A Zakat smart contract could be designed to automatically calculate and

distribute Zakat payments to approved charities or needy recipients, ensuring that the
money is used appropriately. Donors could trace their contributions through the
blockchain, ensuring that their funds are being used for halal (permissible) and ethical
causes.

2. How do Islamic scholars and institutions assess the legitimacy of cryptocurrencies as

a form of currency or investment, and what are the key factors that influence their
rulings on the permissibility of using digital assets?
The legitimacy of cryptocurrencies as a form of currency or investment under Islamic law has
sparked extensive debate among Islamic scholars and financial institutions. The main question
revolves around whether these digital assets comply with the principles of Sharia law,
particularly regarding the prohibition of Riba (interest), Gharar (excessive uncertainty), and the
necessity for transparency and fairness in financial transactions. Islamic scholars and institutions
assess the permissibility of cryptocurrencies through a careful analysis of their features, risks,
and alignment with Islamic ethical and legal principles.

1. Core Principles of Islamic Finance Affecting the Rulings on Cryptocurrencies

Islamic finance is governed by core principles derived from the Qur'an, Hadith (Prophetic
traditions), and centuries of Fiqh (Islamic jurisprudence) scholarship. The key principles that
scholars consider when assessing cryptocurrencies are:

a. Prohibition of Riba (Interest)

Riba, or interest, is explicitly forbidden in Islam, as seen in the Qur'an:

“But Allah has permitted trade and has forbidden Riba (usury)” (Qur'an 2:275).

Cryptocurrencies do not inherently involve interest, but the way they are used in certain financial
products can introduce Riba, such as in lending platforms that charge interest on loans. Islamic
scholars evaluate whether the use of cryptocurrencies in any context leads to Riba.

b. Prohibition of Gharar (Excessive Uncertainty)

Gharar refers to excessive uncertainty, ambiguity, or speculation in contracts or transactions,

which is also prohibited in Islam:

“O you who have believed, do not consume one another’s wealth unjustly or send it [in
bribery] to the rulers in order that [they might aid] you [to] consume a portion of the wealth of
the people in sin, while you know [it is unlawful]” (Qur'an 2:188).

Cryptocurrencies, particularly those that are highly speculative and volatile, raise concerns about
Gharar. Islamic scholars assess whether the unpredictable nature of cryptocurrency prices
introduces excessive uncertainty, which could make transactions involving them impermissible.

c. Transparency and Fairness

Islamic finance promotes transparency, fairness, and the prevention of deceit in financial
dealings. Contracts must be clear, and both parties should have a full understanding of the terms.
Blockchain technology, which underpins cryptocurrencies, offers a transparent ledger of all
transactions, which could align with Islamic principles of fairness and accountability.

• Hadith Example: The Prophet Muhammad (PBUH) said:

“He who deceives us is not one of us” (Sahih Muslim). This teaching emphasizes the
importance of transparency in financial dealings, a quality that blockchain technology
inherently supports through its public, immutable ledger.

2. Key Factors That Influence Rulings on the Permissibility of Cryptocurrencies

a. Nature of the Asset: Currency or Commodity?

One of the first questions that scholars consider is whether cryptocurrencies can be classified as a
legitimate currency or commodity. For a currency to be permissible under Islamic law, it must
fulfill certain criteria, such as being widely accepted as a medium of exchange, having intrinsic
value, and not being subject to excessive speculation.

• Some scholars argue that cryptocurrencies like Bitcoin lack intrinsic value because they
are not backed by a physical commodity like gold or silver. This raises concerns about
their permissibility as a currency under Islamic law.
• Others argue that cryptocurrencies can be treated as a commodity or asset, like stocks or
real estate, which would allow them to be traded if they are not used in speculative or
harmful ways.

b. Volatility and Speculation

The extreme price volatility of many cryptocurrencies has led to concerns about speculation,
which can amount to Gharar. Cryptocurrencies like Bitcoin, Ethereum, and others have seen
dramatic price swings, leading some scholars to view them as speculative investments, which are
discouraged in Islamic finance.

• Example: Scholars point out that speculative trading in cryptocurrencies, where investors
buy digital coins solely to profit from their price fluctuations, could fall under gambling
(maysir), which is explicitly prohibited in Islam:

“They ask you about wine and gambling. Say, ‘In them is great sin and [yet,
some] benefit for people. But their sin is greater than their benefit’” (Qur'an
2:219).
However, if cryptocurrencies are used in a more stable and productive manner, such as for cross-
border payments or as part of a decentralized financial system without speculative trading,
scholars are more inclined to view them as permissible.

c. Underlying Technology: Blockchain Transparency

Blockchain technology, which enables transparent and decentralized financial transactions, is

viewed positively by some Islamic scholars. The transparency provided by the blockchain aligns
with the Sharia principle of bay’ al-amanah (trustworthy sales), as it allows for clear recording
of transactions, ensuring that parties involved in a transaction are fully informed.

• Fatwa Example: In 2018, a Sharia advisory firm in Bahrain, Shariyah Review Bureau,
declared that X8 Currency, a stablecoin backed by fiat currencies and gold, was Sharia-
compliant because of the transparency provided by its underlying technology and the
stability of its value.

d. Use Cases for Cryptocurrencies

Islamic scholars also assess how cryptocurrencies are used. For example, if cryptocurrencies are
used for illegal or unethical activities (e.g., money laundering, terrorism financing, or gambling),
they would be considered haram (forbidden) under Islamic law.

• Permissible Use Cases: Scholars are more likely to rule cryptocurrencies permissible if
they are used for ethical purposes, such as remittances to underbanked populations,
charity donations, or ethical investments. In these cases, cryptocurrencies can be seen
as tools for promoting social justice and financial inclusion, both of which align with
Islamic principles of equity and fairness.

e. Stablecoins and Asset-Backed Cryptocurrencies

Many scholars have shown more leniency toward stablecoins or asset-backed

cryptocurrencies, which are pegged to tangible assets like gold or fiat currencies. These
cryptocurrencies provide greater price stability and reduce speculative risk, making them more
compliant with Islamic principles.

• Example: One Gram, a Sharia-compliant cryptocurrency, is backed by physical gold. It

addresses concerns about Gharar by pegging its value to a tangible asset, thus reducing
speculation and aligning with Islamic law. As a result, it has been considered more
acceptable by Islamic scholars than volatile cryptocurrencies like Bitcoin.

3. Islamic Institutions and Their Rulings on Cryptocurrencies

Several prominent Islamic financial institutions and scholars have issued rulings (fatwas) on the
permissibility of cryptocurrencies. Their views vary based on the specific type of cryptocurrency
and its use.

a. Mufti Muhammad Abu-Bakar

In 2018, Mufti Muhammad Abu-Bakar, a Sharia advisor at Blossom Finance, issued a fatwa
declaring Bitcoin and other cryptocurrencies permissible, particularly when used for ethical
purposes like remittances and financial inclusion. He argued that since Bitcoin operates without
interest and provides transparent financial transactions, it can be considered halal in certain
contexts.

b. Fatwa from Egypt’s Dar al-Ifat

In contrast, Dar al-Ifta, Egypt's leading Islamic authority, issued a fatwa in 2017 declaring
Bitcoin haram due to its extreme price volatility, association with illegal activities, and potential
for speculative trading. They viewed Bitcoin as a source of excessive Gharar and argued that its
unregulated nature posed significant risks.

c. Shariyah Review Bureau (SRB)

The Shariyah Review Bureau, a prominent Sharia advisory firm, has certified several
cryptocurrencies as Sharia-compliant. They assess the cryptocurrency’s underlying technology,
use case, and stability, and have ruled that certain cryptocurrencies, particularly stablecoins, can
be permissible under Islamic law.

d. Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI):

AAOIFI hasn’t issued a firm ruling on cryptocurrencies and it is still uncertain whether it will or
not and respects to this. AAOIFI is still bound to undergo further study as to their compliance with
Shariah principles While blockchain technology has the potential benefits, which of course is to
be welcomed, o IIFA also cautions that before cryptocurrencies are supported, they must be
Shariah compliant, in view of fairness and transparency. Need for further study and consideration
of their compliance with Shariah principles.

e. International Islamic Fiqh Academy (IIFA):

IIFA has expressed cautious optimism, recognizing the potential benefits of blockchain technology
while urging that cryptocurrencies meet Shariah standards regarding fairness and transparency.

a) Individual Scholars and Regional Boards: Sheikh Taqi Usmani (Pakistan): It

suggested that if Bitcoin is used as a medium of exchange, it is permissible; otherwise,
it is not.
 b) Shariah Advisory Council (Various Institutions): Thorough due diligence and
practice of Shariah principles, said many councils, is highly recommended before
councils engage with cryptocurrencies.

Considerations and Emerging Trends

• Central Bank Digital Currencies (CBDCs): Islamic financial institutions are starting to
grapple with the potential that CBDCs would come up with, possibly more regulated and
perhaps Shariah compliant digital monetary systems.
• Smart Contracts and Decentralized Finance (DeFi): However, Islamic finance has new
challenges and opportunities to engage in, which can be related to the rise of smart contracts
and DeFi platforms.
• Educational Initiatives: Blockchain technology and cryptocurrencies needed more
educated Islamic clerics capable of making more informed and elaborated rulings.
Conclusion: The assessment of cryptocurrencies by Islamic scholars and institutions varies
based on several key factors, including the nature of the cryptocurrency, its level of speculation,
transparency, and its use cases. While some scholars view the high volatility and speculative
nature of certain cryptocurrencies like Bitcoin as incompatible with Islamic law, others see
potential for Sharia compliance, particularly with asset-backed or stable cryptocurrencies that
align with Islamic principles of transparency, fairness, and social responsibility. As the
cryptocurrency market evolves and becomes more regulated, it is likely that more nuanced
rulings will emerge, helping to clarify the role of digital assets in Islamic finance.

3. What are the implications of using cryptocurrencies for zakat (charitable giving) in
Islamic finance, and how can blockchain technology facilitate the tracking and
distribution of zakat funds to ensure transparency and accountability?
Zakat is one of the five pillars of Islam, a mandatory form of charitable giving aimed at
redistributing wealth to help the needy and purify the wealth of the giver. Traditionally, zakat is
calculated based on a Muslim’s wealth, and a portion of it (usually 2.5%) is given to those in
need. The rise of cryptocurrencies and blockchain technology presents both opportunities and
challenges in calculating, collecting, and distributing zakat. Cryptocurrencies can streamline the
process, increase transparency, and facilitate better management of zakat funds, ensuring they
are used in a manner that aligns with the principles of Sharia law.

1. Using Cryptocurrencies for Zakat: Challenges and Opportunities

Challenges in Valuation and Volatility

One of the primary challenges in using cryptocurrencies for zakat is their price volatility.
Cryptocurrencies like Bitcoin and Ethereum can experience rapid fluctuations in value, making
it difficult to calculate the amount of zakat owed or the value of a zakat payment over time.
According to Islamic jurisprudence, zakat must be calculated based on the nisab, the minimum
amount of wealth a Muslim must possess before being obligated to pay zakat. The nisab is
typically measured against the value of gold or silver.

• Example: If a person holds cryptocurrency worth $10,000 today, and the price drops to
$7,000 tomorrow, their zakat obligation may fluctuate accordingly. This introduces
uncertainty in meeting the zakat requirements, especially since Islamic law emphasizes
accuracy and fairness in charitable giving. Scholars must determine at what point
(whether daily, weekly, or monthly) cryptocurrency values should be assessed to
calculate the nisab accurately.

Permissibility of Cryptocurrencies for Zakat

Many Islamic scholars and institutions have debated the permissibility of cryptocurrencies as
assets for zakat. The permissibility hinges on whether cryptocurrencies can be classified as
wealth that is subject to zakat. Zakat applies to monetary assets, gold, silver, and business
commodities. Cryptocurrencies, in many cases, are viewed as commodities or assets, making
them eligible for zakat calculation.

• Example: In 2018, Mufti Muhammad Abu-Bakar issued a fatwa declaring that Bitcoin
and other cryptocurrencies are permissible forms of wealth for paying zakat, provided
they are held as an asset for one lunar year and meet the nisab threshold. He reasoned that
since cryptocurrencies are increasingly being used as stores of value, they are subject to
the same zakat rules as traditional wealth like gold or silver.

Opportunity for Financial Inclusion

One of the core objectives of zakat is to redistribute wealth to those who need it most,
particularly in marginalized or unbanked populations. Cryptocurrencies can facilitate financial
inclusion by enabling individuals without access to traditional banking services to both give and
receive zakat through digital wallets. This can be particularly impactful in remote areas where
access to financial institutions is limited, but mobile or internet access is available.

• Example: A person in a rural area without access to banks can receive zakat payments
directly into a cryptocurrency wallet, bypassing traditional financial systems that might
charge high fees or require extensive documentation. This aligns with the Islamic
principle of helping the less fortunate and ensuring that wealth is not concentrated in the
hands of the elite:

“And those in whose wealth is a recognized right. For the beggar and the
deprived” (Qur’an 70:24-25).
Enhanced Transparency and Accountability

Blockchain’s decentralized and transparent ledger system can play a critical role in ensuring that
zakat is collected and distributed in a manner that is fully transparent and accountable. Every
transaction made on a blockchain is recorded on a public ledger that cannot be altered, ensuring
that zakat funds are traceable from collection to distribution.

• Example: A smart contract could be used to automate the collection of zakat from
cryptocurrency holders based on the current value of their assets, and then distribute these
funds to verified recipients. All transactions are publicly visible, ensuring that the process
is transparent and compliant with Islamic law, which emphasizes honesty and
trustworthiness in charitable giving:

"He who does not thank the people is not thankful to Allah" (Sunan Abu
Dawood).

Automating Zakat Distribution via Smart Contracts

Smart contracts—self-executing contracts with the terms of the agreement directly written into
code—can automate the distribution of zakat once specific conditions are met. For instance, once
the zakat calculation reaches the necessary threshold, a smart contract can distribute the funds
automatically to designated recipients or charitable organizations. This reduces human error,
delays, and the potential for corruption, which can occur in traditional systems where
intermediaries manage zakat funds.

• Example: A smart contract could be programmed to distribute cryptocurrency to a list of

approved recipients (e.g., orphans, widows, the poor) based on real-time needs, and once
distributed, the transaction would be permanently recorded on the blockchain, visible to
all participants in the system. This eliminates any chance of misappropriation or misuse
of the funds.

Tracking the Impact of Zakat Payments

Blockchain technology allows for end-to-end tracking of how zakat funds are being used.
Donors can trace their payments from the moment they contribute their zakat to the moment it
reaches its recipients. This ensures that the funds are used for their intended purposes, such as
providing food, shelter, healthcare, or education to those in need.

• Example: A donor could contribute zakat through a blockchain platform and later see
how the funds were used to build a school in an impoverished community. Each step of
the process, from the collection to the implementation of the charitable project, is visible
 and accountable, ensuring that the principles of Ikhlas (sincerity) and amanah (trust) are
upheld.

Reducing Administrative Costs

Traditional zakat collection and distribution systems often involve intermediaries, including
banks, charitable organizations, and government agencies, which can introduce inefficiencies
and administrative costs. Blockchain technology can significantly reduce these costs by
eliminating intermediaries and allowing for direct transfers of zakat from donors to recipients.

• Example: In a conventional system, a portion of the zakat might be used to cover

administrative expenses. However, using a blockchain-based system, a donor can directly
send zakat to a recipient’s cryptocurrency wallet, ensuring that the entire amount reaches
those in need, maximizing the impact of charitable giving.

3. Cryptocurrency Zakat Platforms and Examples

Several organizations and platforms have already begun using blockchain technology to facilitate
zakat payments in cryptocurrency, ensuring transparency, accountability, and financial inclusion.

AID Chain

AID Chain is a blockchain-based platform designed to manage charitable donations, including

zakat, in cryptocurrencies. The platform allows donors to track the entire donation process,
ensuring that the funds are used appropriately and reach the intended beneficiaries. This aligns
with the Islamic principle of ihsan (excellence in action), ensuring that charitable contributions
are managed in the best possible way.

Muslim Charity Platforms

Other Muslim charity organizations are exploring the use of cryptocurrency and blockchain for
zakat payments. Platforms like "Blockchain for Zakat" allow Muslims to donate
cryptocurrency as zakat, which is then distributed to pre-approved Sharia-compliant charities.
This not only provides transparency but also ensures that zakat is used for ethical and halal
purposes.

4. Ensuring Sharia Compliance in Cryptocurrency Zakat

Fatwas and Scholarly Opinions

Several Islamic scholars have provided rulings (fatwas) on the permissibility of paying zakat in
cryptocurrencies. The consensus is evolving, with some scholars approving cryptocurrency
payments if they are properly valued and used for halal purposes. Scholars emphasize that
cryptocurrencies used for zakat must not involve speculation, and their valuation must be
accurate according to the nisab threshold.

• Example: Some fatwas suggest that stablecoins, such as those backed by tangible assets
like gold, are preferable for zakat payments because they reduce volatility and
speculation, thus aligning more closely with Sharia principles.

Conclusion

The use of cryptocurrencies for zakat in Islamic finance offers both significant opportunities and
challenges. While price volatility and the accurate valuation of cryptocurrencies for zakat
purposes present some hurdles, blockchain technology’s inherent transparency and
accountability make it an ideal tool for enhancing the zakat process. Smart contracts can
automate zakat collection and distribution, ensuring that funds are allocated fairly and efficiently,
while the blockchain’s public ledger ensures that all transactions are transparent and trackable.
As Islamic scholars continue to assess the permissibility of cryptocurrencies for zakat,
blockchain technology is likely to play a pivotal role in modernizing and improving the
management of charitable giving in the Islamic world.

4. How can the principles of risk-sharing and profit-and-loss sharing in Islamic

finance be integrated into decentralized finance (DeFi) platforms that utilize
cryptocurrencies, and what innovative financial products could emerge from this
integration?

Integrating Islamic finance principles, particularly risk-sharing and profit-and-loss sharing

(PLS), into decentralized finance (DeFi) platforms involves combining the ethical foundations of
Islamic law (Sharia) with the technological innovations of blockchain. Islamic finance prioritizes
equitable distribution of risk and prohibits interest (Riba) and speculative risk (Gharar). To
achieve this integration, DeFi products must be redesigned to reflect Islamic financial ethics.
Below is a comprehensive explanation, supported by references to Islamic teachings and
scholars, of how these principles can be applied to DeFi and what innovative financial products
could emerge from this integration.

Foundational Principles in Islamic Finance

1. Prohibition of Riba (Interest)

Islamic finance prohibits Riba, which refers to any guaranteed, fixed increase in capital, typically
through interest on loans. The Qur'an clearly condemns Riba in several verses, including:
 "Those who devour usury will not stand except as stand one whom the devil has driven to
madness by (his) touch. That is because they say: Trade is just like usury, but Allah has
permitted trade and has forbidden usury" (Qur'an 2:275).

The prohibition of Riba stems from the idea that earning money from money (as opposed to
legitimate trade or productive investment) is exploitative and unjust, fostering inequality. This is
why DeFi platforms must avoid interest-bearing instruments or lending arrangements that would
violate this fundamental tenet of Islamic finance.

2. Risk-Sharing and Profit-and-Loss Sharing (PLS)

Islamic finance is based on risk-sharing rather than risk transfer. Two important contract types
that embody these principles are Mudarabah and Musharakah:

• Mudarabah: A contract where one party provides capital and the other provides
expertise. Profits are shared based on a pre-agreed ratio, while losses are borne solely by
the capital provider. This promotes risk-sharing without a fixed or guaranteed return.

Classical scholars like Imam Abu Hanifa emphasized the importance of sharing risks, stating
that:
"An investor should not demand a guaranteed return as the outcome of a venture depends on
Allah’s will and the effort made by the parties involved."

• Musharakah: A joint venture where all partners contribute capital and share both profits
and losses according to their capital contributions. This model aligns perfectly with the
decentralized, trustless nature of blockchain technology, which allows participants to
contribute and manage resources collectively.

Integrating Risk-Sharing into DeFi Platforms

Decentralized finance (DeFi) operates through smart contracts, which are self-executing
agreements that automate financial transactions on the blockchain. These contracts can easily
accommodate risk-sharing structures like Mudarabah and Musharakah by automating profit-
sharing and loss-bearing mechanisms. Here’s how these Islamic principles can be incorporated
into DeFi:

Mudarabah-Based Investment Pools

DeFi platforms can create Mudarabah-inspired investment pools, where investors contribute
capital, and entrepreneurs or developers provide expertise. Profits are shared according to agreed
ratios, while losses fall entirely on the investors. Smart contracts could automate this
arrangement, ensuring transparency and fairness.
 • Example: A blockchain-based start-up could raise capital through a Mudarabah
investment pool on a DeFi platform. Investors from around the world could contribute
funds in exchange for a share in the profits, and smart contracts would automatically
distribute earnings according to the pre-determined profit-sharing ratio. In case of losses,
only the capital is lost, without any debt or interest obligations.

Musharakah-Based DeFi Ventures

A Musharakah-based DeFi platform would allow multiple participants to pool resources for
joint ventures. Smart contracts could ensure that all partners share in the profits and losses based
on their contributions, aligning the interests of all parties.

• Example: Imagine a DeFi platform where users can collectively fund a real estate
development project. Each participant owns a portion of the project based on their
financial contribution, and the profits (from rent or sale) are distributed via smart
contracts according to their share. Losses would similarly be distributed, ensuring risk-
sharing.

The Qur'an encourages partnerships that share risk, as it reflects the fairness of trading over
usury:

"O you who believe! Do not devour usury, doubled and multiplied, but fear Allah; that you
may (really) prosper" (Qur'an 3:130).

New Financial Products from Islamic Finance and DeFi Integration

By applying Islamic finance principles, DeFi platforms could create several innovative financial
products:

Sharia-Compliant Staking and Yield Farming

Traditional staking in DeFi allows users to lock their assets and earn interest, which would
violate the prohibition of Riba. A Sharia-compliant version could focus on profit-sharing
models where participants earn returns based on the actual profits of the network, rather than
fixed interest.

• Example: DeFi platforms could create non-interest-based staking pools, where users
provide liquidity to support a network's functionality (e.g., validating transactions) and
earn a share of the network's profits (e.g., transaction fees) rather than interest. This
mirrors the Mudarabah structure, where profits are shared, and losses are borne by
liquidity providers.
Decentralized Takaful (Islamic Insurance)

Takaful, the Islamic equivalent of insurance, is based on mutual risk-sharing rather than
transferring risk to an insurer. In DeFi, Takaful could be implemented through decentralized
risk-sharing pools, where users contribute funds to cover potential losses within the group.
Smart contracts could handle claims transparently and efficiently.

• Example: A DeFi platform could establish a Takaful pool for farmers. Each farmer
contributes a portion of their earnings to the pool, and in the event of crop failure or a
natural disaster, the smart contract automatically disburses funds to the affected farmers.
This aligns with the Takaful principle of mutual assistance, as stated in the Qur’an:

"Help one another in righteousness and piety but help not one another in sin
and transgression" (Qur'an 5:2).

Sukuk (Islamic Bonds) on Blockchain

Sukuk, which are Islamic bonds backed by tangible assets, could be tokenized on the
blockchain. DeFi platforms could issue Sukuk tokens that represent ownership in real-world
assets or projects. These tokens could be traded on secondary markets, ensuring liquidity while
complying with Islamic principles of risk-sharing and asset-backing.

• Example: A government or corporation could issue Sukuk on a DeFi platform, with

each token representing ownership of a share in a real estate development or
infrastructure project. Investors would receive returns based on the project's success
rather than fixed interest payments, aligning with Sharia law.

Sheikh Yusuf DeLorenzo, a leading scholar in Islamic finance, emphasizes that Sukuk should
always be linked to real assets or services to comply with Sharia:

“The most important condition is that Sukuk must represent ownership in tangible assets,
usufruct, or services.”

d. Qard Hasan (Benevolent Loans) on DeFi

Qard Hasan, or benevolent loans, are loans given without interest or profit motive. In DeFi,
these could be automated via smart contracts, where borrowers repay only the principal amount,
and any associated fees would cover operational costs rather than generating profits.

• Example: A DeFi platform could enable Qard Hasan loans for small businesses in
developing countries. Entrepreneurs could borrow capital from the community, and smart
 contracts would ensure the loan is repaid without interest, maintaining compliance with
Islamic ethics.

Challenges and Solutions for Sharia-Compliant DeFi

Volatility and Gharar (Excessive Uncertainty)

One of the main challenges in integrating Islamic finance with DeFi is the volatility of
cryptocurrencies, which can be considered Gharar (excessive uncertainty) and is prohibited in
Islamic finance. To mitigate this, Islamic-compliant DeFi platforms should focus on stablecoins
or asset-backed tokens that have intrinsic value and reduce speculative risks.

• Stablecoins pegged to real-world assets, such as gold or fiat currencies, would minimize
the risk of volatility and reduce Gharar.

Sharia Compliance and Governance

To ensure DeFi platforms adhere to Islamic finance principles, there must be Sharia advisory
boards composed of qualified scholars who can audit the platform's contracts and operations.
These boards could issue fatwas (religious rulings) confirming the compliance of specific DeFi
products with Islamic law.

Conclusion

Integrating Islamic finance principles into DeFi platforms is not only possible but also opens
the door to innovative financial products that promote ethical, risk-sharing, and interest-free
transactions. By leveraging blockchain technology and smart contracts, Sharia-compliant DeFi
platforms could offer Mudarabah-based investment pools, Musharakah ventures, Takaful
insurance, Sukuk tokens, and Qard Hasan loans. These products would adhere to the
fundamental principles of risk-sharing and profit-and-loss sharing, aligning with Islamic
teachings and creating a more equitable financial system. The future of DeFi could very well see
a robust integration of ethical Islamic finance practices, reshaping the way Muslims engage with
decentralized technologies.

5. What challenges do Islamic financial institutions face when considering the

adoption of cryptocurrencies for banking services, and how can they balance
innovation with adherence to Sharia principles?

The integration of blockchain technology and cryptocurrencies offers exciting prospects for
improving financial transactions, transparency, and efficiency. However, these technologies also
introduce elements that conflict with core Islamic tenets, such as the prohibition of Riba
(interest), Gharar (uncertainty), and maysir (gambling). To successfully navigate these
challenges, Islamic financial institutions must carefully balance the potential benefits of
cryptocurrencies with their adherence to Islamic ethical standards, supported by Quranic
guidance.
Key Challenges for Islamic Financial Institutions in Cryptocurrency Adoption
1. Prohibition of Riba (Interest): The prohibition of Riba is a fundamental principle in
Islamic finance, which forbids the charging of interest on loans or investments. In the
conventional financial system, interest (Riba) is a core feature, and many
cryptocurrencies are speculative in nature, often generating returns that are akin to
interest-based profits. For example, Bitcoin and other cryptocurrencies often generate
value through capital appreciation, which can resemble interest. This creates a
fundamental conflict with Islamic financial principles, which require profit and loss
sharing and the avoidance of interest.
Quranic guidance on Riba is clear, as in Surah Al-Baqarah, 2:275, where Allah says:
"Allah has permitted trade and has forbidden interest."
To navigate this challenge, Islamic institutions can explore the creation of Sharia-compliant
digital currencies that operate on a profit-sharing model rather than generating speculative
returns based on market fluctuations.
For example, digital currencies linked to tangible assets, such as gold or real estate, could ensure
compliance with Sharia principles by reflecting real economic activity and avoiding interest-
based profits.
2. Gharar (Uncertainty and Speculation): Cryptocurrencies are inherently volatile and
introduce a high degree of uncertainty (Gharar), which is forbidden in Islamic finance.
Sharia law mandates that financial transactions should be clear, transparent, and free from
excessive uncertainty or speculation. The volatility of cryptocurrencies like Bitcoin and
Ethereum creates speculative risks, as their value can fluctuate wildly within short
periods. This unpredictability makes it difficult to align such currencies with Sharia,
which emphasizes ethical certainty and fairness in contracts and trade.
The Quran addresses the issue of uncertainty and fairness in contracts in Surah An-Nisa, 4:29:
"O you who have believed, do not consume one another’s wealth unjustly or send it to the
rulers in order that they might aid you consume a portion of the wealth of the people in sin,
while you know."
To mitigate Gharar, blockchain technology itself offers an opportunity for more transparent
financial dealings. By recording transactions on a distributed ledger, Islamic financial institutions
can ensure that all contractual terms are clear and transparent, reducing the potential for disputes
and uncertainty. However, the volatility of cryptocurrencies remains a challenge. To address this,
Islamic fintech could focus on stablecoins digital currencies backed by stable assets such as fiat
currencies or commodities, reducing the speculative risks associated with traditional
cryptocurrencies.
3. Maysir (Gambling): The speculative nature of cryptocurrency trading is likened to
maysir (gambling) and is prohibited in Islamic finance. Engaging in high-risk trading and
speculation, where the outcome is uncertain and based on chance rather than productive
economic activity, violates Islamic principles. Cryptocurrencies, particularly through
speculative trading practices like day trading or margin trading, often operate in ways that
mirror gambling, where the potential for profit is dependent on chance and risk-taking.
The prohibition of gambling is directly addressed in the Quran in Surah Al-Ma’idah, 5:90:
"O you who have believed, indeed, intoxicants, gambling, stone alters, and divining arrows
are but defilement from the work of Satan, so avoid it that you may be successful."
Islamic financial institutions can avoid the speculative nature of cryptocurrency trading by
focusing on utility-based cryptocurrencies—those that are used for specific services or goods.
These utility tokens can be linked to Sharia-compliant activities such as halal investing or trade
financing, where the focus is on productive economic activity rather than speculative profits.
4. Technological and Regulatory Challenges: Implementing blockchain technology and
cryptocurrencies requires a significant investment in technological infrastructure,
regulatory oversight, and operational changes. Many Islamic financial institutions are
already grappling with legacy systems that are not optimized for decentralized ledger
technologies. Additionally, the lack of clear regulatory frameworks for blockchain and
cryptocurrencies in various countries, particularly in Muslim-majority regions, adds
another layer of complexity. Governments and regulatory bodies have yet to develop
comprehensive standards that ensure the alignment of blockchain technologies with
Sharia principles.
The Quran emphasizes the importance of justice and fair dealings in all transactions. In Surah
Al-Mutaffifin, 83:1-3, Allah warns against unjust practices:
"Woe to those who give less [than due], who, when they take a measure from people, take in
full. But if they give by measure or by weight to them, they cause loss."
Islamic financial institutions must work closely with regulators to establish Sharia-compliant
guidelines for the use of blockchain technologies. These guidelines should emphasize
transparency, ethical governance, and the avoidance of Riba, Gharar, and maysir. Furthermore,
Islamic fintech firms should invest in developing smart contracts, which can automate
compliance with Islamic principles, ensuring that all terms of the contract are executed fairly and
transparently.
5. Social and Ethical Considerations: Islamic finance is deeply rooted in social justice,
ethical business practices, and the promotion of social welfare. Key Islamic social finance
 tools such as zakat (obligatory almsgiving) and waqf (charitable endowment) are integral
to the Islamic financial system. The use of cryptocurrencies in these areas introduces both
opportunities and challenges. Blockchain technology offers the potential for greater
transparency in zakat collection and distribution, ensuring that funds are properly
allocated to those in need. However, ensuring that cryptocurrencies used in such activities
are free from unethical or illegal origins (e.g., money laundering, terrorism financing)
remains a challenge.
The Quran encourages transparency and accountability in charitable giving, as highlighted in
Surah Al-Baqarah, 2:267:
"O you who have believed, spend from the good things which you have earned and from that
which We have produced for you from the earth. And do not aim toward the defective
therefrom, spending [from that] while you would not take it except with closed eyes."
Blockchain technology can provide a transparent ledger for tracking zakat and waqf payments,
ensuring that these funds are used for their intended purpose and distributed ethically.
Additionally, Sharia-compliant cryptocurrencies could be developed specifically for zakat
payments, ensuring that the technology supports the broader social goals of Islamic finance.
Opportunities for Blockchain in Islamic Finance
Despite the challenges, blockchain technology offers several opportunities for Islamic financial
institutions to innovate while adhering to Sharia principles. Some potential areas of application
include:
• Smart Contracts: Blockchain-based smart contracts can automate Islamic financial
transactions, ensuring that all terms comply with Sharia law. These contracts can
eliminate uncertainties and reduce transaction costs, particularly in areas such as sukuk
(Islamic bonds) and halal investments.
• Cloud Storage for Islamic Finance: Blockchain-based cloud storage solutions can help
Islamic financial institutions store and manage large amounts of financial data securely
and transparently. This can mitigate risks associated with data storage and help
institutions comply with Sharia's emphasis on trust and transparency.
• Smart Sukuk and Takaful (Islamic Insurance): Blockchain can streamline the issuance
and management of sukuk, ensuring greater transparency, efficiency, and cost savings.
Similarly, smart contracts can revolutionize takaful by automating the claims process,
reducing fraud, and ensuring that payments are made fairly and quickly.
Quranic guidance emphasizes transparency, justice, and the prohibition of interest and gambling,
all of which must be carefully considered as Islamic financial institutions explore this new
frontier. (Muhammad Hassain, January 2024)
 6. Considering the volatility of cryptocurrencies, how should Islamic financial
practitioners advise their clients on the risks associated with crypto investments
while adhering to the Islamic prohibition on excessive uncertainty?
1. Educating Clients on Risk and Volatility:
The first step for Islamic financial practitioners is to provide thorough education about the
inherent volatility of cryptocurrencies. Many cryptocurrencies, including Bitcoin, experience
sharp price fluctuations due to their speculative nature and market-driven value. Clients should
be made aware that while cryptocurrencies have potential for high returns, they also carry a high
risk of loss. Educating clients about these risks is essential to ensure informed decision-making.
2. Distinguishing Between Speculation and Legitimate Investment:
One of the core principles of Islamic finance is the avoidance of maysir (gambling) or
speculation. In cryptocurrency trading, speculation is common due to its price volatility, which
can lead to significant gains or losses in short periods. Islamic financial practitioners must guide
their clients away from speculative trading practices and toward legitimate investment
strategies.
They should explain that while investing in cryptocurrencies for long-term value appreciation
may be permissible under certain circumstances, speculative activities such as day trading or
short-term investments that are driven purely by market swings are more akin to gambling and
violate Shariah principles.
This caution against speculative risk encourages clients to focus on projects and coins that offer
real utility and align with Islamic ethics, such as those related to halal business practices,
blockchain technology for transparency, or assets backed by real-world value.
3. Recommending Diversification:
Another key piece of advice Islamic financial practitioners should give is to diversify their
investment portfolio. In Islamic finance, diversifying investments is a well-established strategy
to minimize risk and reduce exposure to uncertainty. Clients should be advised not to allocate a
large portion of their wealth into cryptocurrencies due to their high volatility, but rather invest in
a range of Shariah-compliant assets, such as real estate, sukuk (Islamic bonds), and commodities.
By recommending a diversified investment strategy, practitioners help their clients avoid
excessive exposure to one asset class, which reduces the potential for severe losses, especially in
volatile markets like cryptocurrencies.
4. Avoiding High-Risk Offerings like ICOs:
Initial Coin Offerings (ICOs) often pose a higher risk of Gharar due to the lack of
transparency and clarity about the underlying assets and investor rights. Islamic financial
practitioners should strongly caution their clients against investing in ICOs, as they frequently
lack sufficient disclosure about the actual value of the tokens being issued and the legality of the
projects, they are funding.
In cases where there is excessive uncertainty about what is being purchased and no clear
protection of the investor’s rights, such investments would fall afoul of Shariah’s prohibition on
Gharar. Practitioners should instead recommend investment opportunities with a clearer risk
profile, where due diligence can be performed effectively.
5. Ensuring Compliance with Local Laws and Regulations:
In jurisdictions where cryptocurrency is banned or not recognized as legal tender, Islamic
financial practitioners must advise clients to follow the local laws. Even if a cryptocurrency is
considered Shariah-compliant, it may not be permissible to use it for transactions in certain
regions. Islamic finance emphasizes respect for local regulations, as stated by scholars like
Sheikh Yusuf al-Qaradawi. This is also aligned with the Islamic legal maxim: "The law of the
land is law."
6. Emphasizing Ethical and Social Responsibility:
Finally, Islamic finance is deeply rooted in principles of social justice and ethical investing.
Practitioners should ensure that their clients’ cryptocurrency investments are aligned with these
values. This means avoiding cryptocurrencies or blockchain projects that could be linked to
illegal activities, unethical business practices, or environmental harm. The Quran encourages
fairness and ethical dealings, as stated in Surah Al-Baqarah, 2:275:
"Allah has permitted trade and has forbidden interest."
By guiding clients to invest in ethical, Shariah-compliant cryptocurrency projects, practitioners
uphold Islamic finance's commitment to social responsibility and the promotion of justice in
financial transactions.
7. According to majority Fuqaha’s (Islamic Scholar’s) Cryptocurrency Shairah
permissibility still doubted in Islamic financial system. Discuss your opinion by
giving arguments in its favor and against its permissibility.
Bitcoin is halal (permissible) or haram (forbidden) from an Islamic perspective, highlighting
both the arguments in favor of and against its permissibility according to Islamic scholars and
Shariah principles.
Arguments in Favor of Bitcoin’s Permissibility
Bitcoin Qualifies as Islamic Money: According to Blossom Finance’s working paper, Bitcoin
meets the economic functions of money: it serves as a medium of exchange, a unit of account,
and a store of value. These roles are critical in Shariah for defining what constitutes "money."
Additionally, Bitcoin qualifies as Islamic customary money in jurisdictions where it is widely
accepted or recognized by the government. In Islamic finance, customary money is anything that
achieves acceptance as a currency through societal usage or legal mandate, making Bitcoin
permissible under certain conditions, such as in countries like Germany where it is legally
recognized. As argued by Mufti Muhammad Abu Bakar, a recognized Shariah advisor at
Blossom Finance, Bitcoin fulfills the economic roles of money medium of exchange, unit of
account, and store of value. According to Mufti Abu Bakar, Bitcoin is permissible because it
functions similarly to gold and silver, which are accepted as money in Shariah when used widely
in trade and commerce.
This is consistent with Shariah principles that recognize any widely accepted form of currency,
which doesn't inherently violate Islamic law, as permissible. For example, the practice of using
gold and silver (historically known as Dinar and Dirham) as customary money can be extended
to Bitcoin if it is widely accepted as a legitimate form of exchange.
Blockchain’s Compatibility with Shariah: Blockchain technology, the underlying technology
behind Bitcoin, aligns with several key Shariah principles. Blockchain ensures ownership
verification and prevents fraudulent transactions, which promotes transparency—a central tenet
in Islamic financial transactions. The Quran emphasizes the importance of justice and honesty in
financial dealings, as stated.
"O you who have believed, when you contract a debt for a specified term, write it down. And
let a scribe write between you in justice..."
Furthermore, blockchain is compatible with the Shariah prohibition of fractional reserve
banking, a system where conventional banks create money through lending beyond their actual
reserves, leading to interest-based profit (Riba). Blockchain avoids this practice by ensuring that
Bitcoin is fully owned and not based on debt creation, aligning with Shariah’s requirements for
fair and ethical financial practices.
Sheikh Haitham al-Haddad, a prominent Islamic scholar in the UK, who suggested that Bitcoin
could be halal (permissible) if it fulfills the functions of money and is not tied to illegal activities.
He acknowledges that Bitcoin’s nature as a decentralized, verifiable currency gives it certain
attributes that can comply with Islamic finance when not used speculatively.
External Factors Do Not Invalidate Bitcoin’s Permissibility: Some Islamic scholars argue that
Bitcoin is impermissible due to its volatility or potential misuse for illegal activities. However,
according to
Sheikh Imran Hosein, a prominent Islamic scholar known for his work on Islamic eschatology
and economic system rejects this reasoning, noting that external factors like price volatility or
illegal uses do not make Bitcoin itself harm. Volatility is a characteristic of many lawful assets
(such as commodities), and its potential misuse for unlawful purposes does not inherently make
it impermissible, like fiat currencies that can also be used unlawfully.
Arguments Against Bitcoin’s Permissibility
Volatility and Gharar (Excessive Uncertainty): Many Islamic scholars, including Mufti Faraz
Adam, a leading authority on Islamic fintech, express concerns over Bitcoin's volatility and its
potential for Gharar (excessive uncertainty). Mufti Faraz argues that Shariah mandates the
protection of wealth, and the extreme price fluctuations seen in Bitcoin may result in financial
losses that violate this principle. Mufti Menk, a globally recognized Islamic scholar, has also
warned against engaging in speculative activities with cryptocurrencies due to their volatility,
noting that excessive speculation contradicts the Islamic principle of risk management and
wealth preservation. One of the main concerns regarding Bitcoin’s permissibility under Shariah
is its extreme volatility and the resulting risk of Gharar, which refers to excessive uncertainty in
transactions. Shariah seeks to preserve and protect wealth, and the high volatility of Bitcoin
poses a significant risk to investors, which could be seen as exposing individuals to unnecessary
financial losses. Islamic scholars argue that engaging in highly speculative investments that carry
excessive uncertainty. Moreover, initial coin offerings (ICOs) are another aspect of
cryptocurrency investment that raises concerns. Many ICOs lack transparency and clarity, which
further introduces uncertainty, making such investments potentially impermissible due to Gharar.
Speculative Nature and Maysir: Sheikh Assim al-Hakeem, an Islamic scholar known for his
rulings on modern financial issues, categorically considers Bitcoin and similar cryptocurrencies
as haram due to their speculative nature, equating them with maysir (gambling). He argues that
the sharp rise and fall in Bitcoin’s value make its trading akin to gambling, as it lacks stability
and introduces unnecessary risk. The speculative nature of Bitcoin trading leads some scholars to
argue that it falls under this prohibition, as its volatility makes it a high-risk investment akin to
gambling.
Regulatory Uncertainty and National Law:
Sheikh Yusuf al-Baradari, a renowned Islamic scholar, has stated that compliance with local
laws is crucial in determining whether an economic activity is permissible, especially in matters
where the state has clear directives regarding financial practices. While Bitcoin may be
permissible under Shariah, its use as currency may be forbidden in certain jurisdictions where
local laws prohibit Bitcoin transactions.
Shariah scholars argue that national laws must be respected, and when a government explicitly
forbids the use of Bitcoin for payments, it becomes impermissible in those regions. For example,
in Indonesia, while Bitcoin trading is allowed, it cannot be used for payments due to the legal
requirement that all transactions be made in Indonesian Rupiah. This makes Bitcoin haram for
use as a currency in such regions.