Cryptocurrencies (also currency tokens) are encrypted digital currencies such as Bitcoin or Litecoin.
In general, cryptocurrencies are backed by a blockchain-based decentralized, distributed and encrypted payment system. Cryptocurrencies that run on their own independent platform (e.g. Bitcoin, Ether or Litecoin) are referred to as Coins. Currencies that use a third-party platform, on the other hand, are referred to as currency tokens or payment tokens.
The fundamental idea behind cryptocurrencies is to ensure cashless (peer to peer) payment transactions without the supervision or involvement of central control mechanisms (e.g. central banks or authorities).
Cryptocurrencies such as bitcoin have laid the foundation for something that, in the age of digital transparency and surveillance capitalism, provides consumers with a way to securely enter into smart contracts and have them guaranteed to be executed without the need for a central party or intermediary. The more participants the system has, the more monitor each other, and the more secure the system becomes.
At the same time, it is possible to move assets almost completely anonymously, as participants do not need to participate with their real names, but with pseudonyms composed of numbers (e.g., Bitcoin addresses). Thus, in some states, cultures, and industries, cryptocurrencies enable the free (and secure) exchange of goods and services in the first place and protect the identities of participants (e.g., from state power in dictatorial regimes).
In order to purchase cryptocurrencies, one needs a so-called wallet, that will store the currency. There are several cryptocurrency trading platforms where wallets can be created. After creating a wallet, one can start buying and selling cryptocurrencies. With the interest in cryptocurrencies growing, a lot of online brokers are starting to offer the exchange of cryptocurrencies.
Cryptocurrencies are different from e-money.
Unlike fiat currencies most cryptocurrencies have a limit of units which is determined in the source code. This bears a resemblance to rare metals like gold, that, unlike fiat money, have an inflation protection. Furthermore, transaction fees compared to international transactions between bank accounts.
Most coins are currently not linked to a specific currency. Therefore, they are not e-money (electronic cash) by definition, but virtual currencies. According to the commonly acceped definition of e-money, "there must be an issuer that issues the e-money against a claim."
However, this is not the case with cryptocurrency transactions, as the virtual currency serves to digitally represents a value but has no connection to the financial system or a legal tender. On the contrary, the idea behind cryptocurrency is that it works completely without a central authority and every transaction is documented and traceable for all users of the blockchain.
Nevertheless, some argue that the definition of e-money should be expanded, because e-money and cryptocurrency do share common characteristics: As with electronic money, Bitcoin, Ethereum or other cryptocurrencies can be transferred from sender A to receiver B without a flow of cash payment - but rather the purely virtual currency.
For the transfer, a user generates a cryptographic key pair (asymmetric encryption) with a Bitcoin wallet (or similar). If a Bitcoin is to be transferred from A to B, sender A adds the public key of recipient B to the amount using software (for example, via the wallet). In order to protect the transfer from filters and hacker access, two protective mechanisms take effect: First, the validity of the Bitcoin is checked before the transaction and second, all transactions are recorded in a public list.
Demand for cryptocurrencies and tokens is growing.
No asset class has ever seen higher growth than bitoin and the like, with cryptocurrencies eclipsing stocks, bonds, and even the tulip mania of the 16th century. Despite, or perhaps because of, the extreme volatility that comes with extreme growth opportunities, crypto investing offers an interesting balance to traditional "safe" investments.
In principle, crypto assets offer investors three key advantages: They open up unlimited growth potential, they offer diversification effects, and they act as an anti-inflationary store of value.
At the same time, however, crypto investing is also significantly more complex than is the case with traditional asset classes. This poses a significant challenge for professional asset managers, who must master the complexities of crypto technology, address significant security concerns as well as the impact of crypto activity on the balance sheet, anti-money laundering, and asset custody, and integrate crypto assets into the existing investment process. At the same time, market liquidity, settlement, and compliance in the crypto space are just in the early stages.
Did you know? Most cryptocurrencies are Islam-compliant and are therefore also suitable for Islamic finance!
Modern Islamic scholars are also addressing blockchain and tokens. In 2019, speakers from Amanie Advisors, the leading Sharia advisory firm in Islamic finance, took an official stance in a "Shariah Whitepaper" proclaiming: Bitcoin, Ethereum and co. are halal - as long as they do not generate profits from interest.
The basis of the chain of argumentation is that Bitcoin is virtual gold that is obtained through "mining" and is not created in an inflationary manner. Accordingly, cryptocurrencies have the same intrinsic value that Islamic law requires to recognize a currency as halal. Furthermore, digital currencies are considered asset-based, while the traditional currency system is debt-based.
The assets behind bitcoin, according to the logic of the argument, exist in the nature of bitcoin: first, its maximum number (the resources) is limited; second, it is created via a mining process; third, it is based on real computing power (energy input); and fourth, bitcoin mining does not create debt, which is why proponents refer to bitcoin as digital gold. Additionally, blockchain transactions are not based on profit-and-loss contracts, but on so-called smart contracts.
This makes Bitcoin and co. (theoretically) more halal than any physical currency. At least for now, the development of blockchain technology remains exciting in Islamic banking.
