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Bitcoin and Islamic Finance

Matthew Martin
By Matthew Martin
6 years ago
It is argued that a Bitcoin-style money-like informational commodity may constitutean effective instrument for the further development of Islamic Finance. The argumentinvolves the following elements: (i) an application of circulation theory to Bitcoin with theobjective to establish the implausibility of interest payment in connection with Bitcoin,(ii) viewing a Bitcoin-like system as a money-like exclusively informational commoditywith the implication that such a system need not support debt, (iii) the idea that IslamicFinance imposes different requirements compared to conventional financial policies ona money concerning its use as a tool for achieving social and economic objectives, and(iv) identification of two aspects of mining, gambling and lack of trust, that may bothbe considered problematic from the perspective of compliance with the rules of IslamicFinance and a corresponding proposal to modify the architecture of mining in order toimprove compliance with these rules.Keywords and phrases: informational money, exclusively informational money, moneylikeinformational commodity, IFR compliant finance, Bitcoin.

Ard, Dinar, Islam, Mal, Shariah , Participation

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  1. Bitcoin and Islamic Finance (version 3∗) Jan A. Bergstra Informatics Institute, University of Amsterdam email: j.a.bergstra@uva.nl January 1, 2015 Abstract It is argued that a Bitcoin-style money-like informational commodity may constitute an effective instrument for the further development of Islamic Finance. The argument involves the following elements: (i) an application of circulation theory to Bitcoin with the objective to establish the implausibility of interest payment in connection with Bitcoin, (ii) viewing a Bitcoin-like system as a money-like exclusively informational commodity with the implication that such a system need not support debt, (iii) the idea that Islamic Finance imposes different requirements compared to conventional financial policies on a money concerning its use as a tool for achieving social and economic objectives, and (iv) identification of two aspects of mining, gambling and lack of trust, that may both be considered problematic from the perspective of compliance with the rules of Islamic Finance and a corresponding proposal to modify the architecture of mining in order to improve compliance with these rules. Keywords and phrases: informational money, exclusively informational money, moneylike informational commodity, IFR compliant finance, Bitcoin. ∗ This is a revised version of [7]. Two aspects have been modified with respect to Version 2 of the paper. The virtue of initial non-moneyness of a money-like informational commodity with respect to the plausibility of a transitional phase towards its use for the purpose of Islamic Finance has been emphasized more clearly. Further the question concerning compliance of Bitcoin, and in particular of Bitcoin mining, with the requirements of Islamic Finance has been reconsidered on the basis of comments from different sources. On the one hand the legitimacy of certain lotteries has been brought to my attention, and that matter is undoubtedly related to this issue, on the other hand I have been asked to clarify my position concerning the methodology of writing about compliance of any feature in general given my position as a non-Islamic author and given the fact that my writing about this matter cannot possibly be considered authoritative in the same way as that of a relevant Shariah Board about the same matter might be considered in principle. For the analysis of IFR-compliance of mining I acknowledge the very useful suggestions made to me by an anonymous person by email. The same person had been providing helpful suggestions already before for the improvements leading too version 2 of the paper. 1
  2. Contents 1 Introduction Following [14] I will classify Bitcoin as a money-like informational commodity (MLIC). The virtue of this classification is claimed to be that it is technically defensible while it involves no premature commitment to an answer in either direction to the question whether or not Bitcoin is a money. An MLIC may evolve through a life-cycle where it begins as a non-money, then functions as a money, and finally returns to a non-money status. This flexibility of an MLIC with respect to its moneyness is especially important for candidate informational moneys with a more or less rigid and fixed technology. For such informational commodities moneyness correlates with usage and acceptance by a significant and relevant fraction of the public. The discussion below of the potential connections between Bitcoin and Islamic Finance is not dependent on the actual moneyness of Bitcoin and can be read with the understanding that Bitcoin is an MLIC that might (but need not) evolve into an informational money for which its moneyness is undisputed. The probability that of Bitcoin will become an undisputed informational money in part depends on its perceived usefulness for Islamic Finance. 1.1 About Islamic Finance Following [8] I will characterize Islamic Finance as any system where all ethically correct financial transactions and agents are supposed to comply with the five rules mentioned below (thus following the exposition of [9] and simplifying the description in [4]). Instead of speaking of Islamic Finance I prefer to speak of Islamic Finance Requirements which may be met in a financial system to varying degrees. An additional advantage of this way of using the terminology is that a financial system will not be Islamic simply because its governors prefer to label it that way. 1.1.1 Islamic Finance Requirements (IFR) I will use this set of requirements as a definition of IFR. Instead of Islamic Finance I will prefer to use the phrase IFR compliant finance. Interest prohibition (IP). Interest on debt must neither be asked and received nor promised and paid. No misleading. Agents should not mislead their trade partners. Trade partners are entitled to know what they buy. Further trade partners must be able to take their own decisions in freedom. 2
  3. True entity requirement . Transactions against money must deal with existing goods and services (true entities). Gambling prohibition (GP). Gambling is forbidden. Mandatory donation. Agents must donate a reasonable fraction of their income to those in need. 1.1.2 Some remarks on IFR Much can be said about the origin of these rules and about the effects such rules may have on an economic system for which compliance with those rules is sought. I will only provide a number of scattered remarks that I collected on the basis of a recent effort to read a number of (English, Dutch, French, and German) texts about Islamic Finance. 1. These five principles of Islamic Finance can be viewed as a conceptual option for organizing a financial system independently of its Islamic background. One may wish to experiment with the same bundle of principles for different reasons. In principle supporting IFR is an option from a non-Islamic perspective just as well.1 In [4] I have proposed to refer to a financial system compliant with (a somewhat different phrasing of) these rules as a (rules of) Crescent-Star Finance (CSF), thus expressing the potential decoupling from its Islamic background which might promote a wider acceptance outside Islamic circles. 2. I do not hold in any manner that these five principles (of IFR) provide either a better theory of money or a better economic system than so-called conventional or Western principles. What can be argued convincingly, however, is that these principles differ from conventional ones and for that reason alone the implications of IFR merit investigation. 3. The fact that these principles can be understood as being compliant with Islamic views is independent of these principles as such. 4. For each of these principles the following questions arise: (a) what does it mean in practice (what is the importance of case history), (b) how to deal with borderline cases (in theory), (c) how principled should one be in seeking compliance (who takes decisions), (d) how about consistency with the other rules (parametrized by one’s economic background theory), (e) what are implications of the rule as a restriction one one’s behavior when one’s financial actions are embedded in a financial system that is not compliant with these five rules, 1 I have become intrigued by Islamic finance because of the parallel with computer programming: disallowing options or mechanisms in a program notation need not make that program notation weaker than previous more liberal notations. Is a strengthening of the financial system a conceivable outcome of what seems at first sight to be a drastic reduction of its operational options? (See also [11].) 3
  4. (f) in the light of which financial and economic background theory must the rule be understood (both in terms of current economic theory and in terms of its historic development), (g) is the rule incorporating restrictions for individual persons or rather for entire financial and economic systems, (h) in which cases can the rule be ignored or compromised at the level of financial system design. These questions arise from a non-Islamic perspective just as well as from an Islamic perspective. Needless to say views on these issues differ through the Islamic world in just the same way as views on economic matters vary in conventional finance and economics. 5. The consistency of Islamic finance is mostly taken for granted, but it is not at all a trivial matter. That issue has been discussed in [11] by pointing out methodological aspects of the matter, however, without arriving at a conclusive result. Cristian (pre-reformation) support for interest prohibition had to give way in the view of its inconsistency, which came about by simulating interest payment as a result of financial engineering by means of a sequential arrangement of ethically accepted (at that time, and in the context of IP) transactions. It is remarkable that scholars of Islamic Finance do not commonly express the need to demonstrate that IPR (or any improved version of it) is consistent, given the fact that a Christian ideology starting out with a comparable commitment to IP failed to sustain that commitment. 6. The intuition of IP is most easily understood in a setting where all income must be earned as an unpredictable profit from sequences of business transactions. Assuming that at time t agent A borrows amount x from agent B, and A agrees to pay back (1 + p) · x to B at time t + k (e.g. 1 year later). Now one may consider the amount p · x an interest and oppose to the agreement on that basis. But if at time t it is already sure that at time t + 12 · k A will receive an amount y > (1 + p) · x from agent C then A thinks in terms of delayed payment to B rather than in terms of interest. However, the more plausible interpretation of IP results if one assumes that B has no income guarantees at time t. In that case B “sells” a profit (by promising to pay (1+p)·x to B at time t + k) that is unavailable (by simply keeping x in stock in preparation of returning it to A, the income is unlikely to be created by B) at time t and which may just as well turn out to be a loss. That is the surplus p · x over x can only be earned as a profit from business entertained after t and as such its existence is in doubt. That implies that in this case IP follows from the “true entity requirement”. B should not entertain a transaction where an entity that does not yet exist (and may never exist in all likelihood) is exchanged for whatever other entity.2 7. It is evidently somehow problematic to write about Islam or about Islamic Money from a position outside Islam. In [2] I have given both a justification for and a systematic risk 2 This argument can be turned around by stating that where regular income guarantees for A prevail, the payment of interest to A may be considered more justifiable. 4
  5. analysis of writing about Islamic matters from a Christian background as well as from an agnostic background . With reference to [2] I mention that the manifest importance of Islam for all human beings, irrespective of their religious views, justifies and even requires its analysis from external positions. 8. Again with reference to [2] I mention that Islam is large, varied, and very complex, and that hardly any generalizing assertion about Islam can be justified. My point of view is that Islam should be understood and approach by external observers with a positive attitude. That positive attitude implies an understanding of the fact that the Islam should not, or at least need not, be identified with its extreme forms. Rather the other way around one should feel invited to develop a positive attitude towards Islam, because only then its potential impact can be fully appreciated. I consider an appreciation of the following issues helpful in this context. (a) The influence of Islam on Western thought has been significant and its mediating role in transferring Greek Philosophy to the West has been essential. (b) Although Islam may be considered a political system with some justification, that by itself does not imply that it is either outdated or that it embodies a deficient understanding of the separation between the state and the religious institutions (I refer to [2] for an elaboration of this matter). (c) As a system of governance what Islam prescribes, suggests, or promotes, bears some similarity to how “Western” science runs itself. There are no democratic elections in science, and that absence is supposedly justified with the argument that “truth”, the topic of science, is a matter too important to be left to the erratic outcomes of democratic elections. Instead of Sharia boards, science has editorial boards, program committees, and grant awarding bodies. These groups always have to take principles of scientific integrity and competence in to account. Science allows competing teams (nations, factions) to express different views at the same time and is reluctant to accept the single authority of monolithic international bodies. 9. In [11] an attempt has been made to analyze in detail the technical content of interest prohibition. The following conclusions were drawn: (a) Interest prohibition turns a system into a so-called a RPSF (reduced product set finance). With reference to classical principles of program notation design it is concluded that the restrictions of an RPSF need not necessarily render it weaker as a financial system than its unrestricted proxies in the space of financial systems. (b) The concept of interest is by no means easy to define, not even in a setting of modern finance, because it ultimately depends on the outcome an analysis of the undisputed cost incurred by a lender when lending money to a borrower. (c) The idea that the original Islamic sources contain a theory of money which is sufficiently detailed to allow the specification of interest in a way that is or convincingly transferable to a modern financial system is lacking plausibility. 5
  6. From the perspective of an outsider the picture can be simplified by assuming that the concept of interest prohibition came to the forefront of Islamic thought in the context of the adoption of Greek philosophy as an important source for its philosophers . Aristotle opposed interests and so did Judaic ethics for several millennia. Events before and during the reformation moved (Roman Catholic) Christianity into accepting interest payments, though with considerable reluctance only.3 10. That a financial system satisfies the rules of IFR does not imply ethical virtue per se. Even if Bitcoin or an appropriate alternative for it provides for a financial system compliant with IFR rules, its adoption may lead to many ethical questions some of which are rather pressing. I refer to [8] for an initial survey of ethical issues in connection with Bitcoin. 1.2 About interest prohibition and debt avoidance Much attention in the literature on Islamic Finance is paid to the effects of and the rationale for Interest Prohibition (IP). In [3] I have attempted to describe the roots of IP. As far as I can see the supporters of IF do not claim that money can be borrowed by A from B without any cost for B, and not without risk for B either. Moreover initial transaction costs of a lending transaction are usually permitted by proponents of IP. In [11] the difficulties of precisely specifying what must be considered interest have been scrutinized. This is a difficult topic about which the literature on Islamic Finance seems to be rather uninformative with as a consequence that a payment may be considered forbidden merely because the description “interest” is assigned to that payment by an agent who is unaware of the consequences of that labeling. That agent is likely to be unaware of the necessity to provide a (potentially nontrivial) explanation as to why that payment is (and must be) considered an interest payment. A common method for implementing IP is the avoidance of debts. Debts and interest go hand in hand. Islamic finance and trade provides many forms of cooperation that allow financing and workload for an activity to be unevenly distributed over a number of parties without the need to create debt positions in any direction. In [11] the well-known (almost classical) observation has been outlined that the transaction costs of such forms of cooperation are in some cases unexpectedly high and may in some cases be considered prohibitive. I will argue that by viewing Bitcoin (or rather a Bitcoin-like informational money) as a so-called exclusively informational money (EXIM, see [8]) debt (in terms of that informational money) turns into an implausible feature and as a consequence interest (in connection with that informational money) becomes both unnecessary and implausible. 1.3 About Islamic Logic (IL) At first sight the phrase Islamic Finance seems too be comparable to the phrases Islamic Art and Islamic Logic. This is unconvincing, however, because Islamic Art and Islamic Logic can 3 Interest prohibition has been quite universal in the past, and one might claim that its removal from prominence primarily signed a change in the conception of money, and not a change in the appreciation of interest payment. 6
  7. be identified with art and logic from a specified historic period and geographic region . In contrast Islamic Finance is a recent movement with roots in the early years of of the 20th Century.4 In [2] I have made an attempt to redesign Islamic Logic as a modern theme in such a way that, just as Islamic Finance, its use may be specifically useful for achieving Islamic objectives. Redesigning IL along such lines is a risky project because some interpretation of Islamic objectives is unavoidable. Today’s practice of Shariah Boards, however, calls for an investigation of common reasoning patterns used by such bodies. The suggestions of [2] are preliminary only and extensive subsequent theoretical and empirical research will be needed to assess their relevance. The resulting approach to Islamic Logic was termed Real Islamic Logic (RIL).5 The main conclusion of [2] is that paraconsistent logics ought to play a central role in any RIL. (For a recent survey of paraconsistent logics see [22]). Another conclusion is that RIL makes use of prioritized rules with many different levels of priority (I counted up to 9 such levels which defeats any formal analysis by means of methods known in today’s theoretic computer science to mention an area where prioritized reasoning has become quite common). These two features render RIL very different from conventional formal logics, their combination presenting ample novel challenges for the modern logician. Taking a more modern (instead of historic) approach to Islamic Logic is plausible, because, at least in principle, that kind of logic is needed when one intends to reason about how to apply a IFR compliant Finance to an actual problem in a way which conforms to time and place dependent manifestations of Islamic principles. RIL is primarily a human reasoning style, and RIL needs to be applied when matching the rule based constraints of IFR compliant money to a specific context. The final and admittedly rather speculative conclusion of [2] is that RIL carries a relatively high perspective (in comparison to other informal logics) to defeat attempts for automation and virtualization. This (claimed) robustness against the potential ubiquitous advance of software robots in applied ethics may not be considered an important issue today, but it may become critical in a not so distant future. 4 Islamic Art and Islamic Finance have in common the noticeable impact of restrictive rules of conduct. Islamic Logic, however, seems not to embody or to incorporate any restrictive rules of conduct that are supposedly specific to an Islamic context. 5 Perhaps Current Islamic Logic (CIL) would have been a better phrase than RIL because CIL allows for the existence of a discrepancy between what Shariah Boards actually do (if common patterns can be found) and what they ought to do (if it is not taken for granted that their judgments are in sufficient compliance with Islamic Principles). When contemplating RIL, I have made an attempt to reconcile an external perspective (that from a religiously indifferent external observer) and a hypothesized internal perspective (from an observer who tries to feel convinced by core principles of the religious ideology at hand). This thought experiment is highly problematic from a methodological viewpoint, but I hold that only by performing such thought experiments one may gain access to the mechanics of said common reasoning patterns (assuming that such patterns can be reliably determined). Needless to say this thought experiment may have different outcomes for different persons (and even for the same person in different circumstances) and for that reason I do not claim in any manner that the outcome reported in [2] should be predictive for outcomes arrived at by other individuals when attempting to carry out a corresponding thought experiment. 7
  8. 2 Bitcoin : a Money-like Informational Commodity (MLIC) Bitcoin, both in its design and in its development, contributes to the understanding of the concept money. This contribution is visible already from the ongoing debate concerning its moneyness. In [14] the proposal was made to classify Bitcoin in such a way that the question whether or not it constitutes a money need not be settled in advance. By labeling (typing, classifying) Bitcoin as a money-like informational commodity (MLIC) a significant flexibility is obtained. Indeed, viewing Bitcoin as an MLIC is compatible with a life-cycle where it starts and terminates its existence as a non-money, with one or more episodes of (“true”) moneyness (rather than mere “money-likeness”) in between. 2.1 About Bitcoin and about money Bitcoin is supposed to originate from the same yet unknown source as [23]. It is common to consider Satoshi Nakamoto as Bitcoin’s originator in spite of persistent lack of clarity about the pseudonymous status of this name. One may consider the development of Bitcoin a step forward in the development of information (see [17]) as a core philosophical concept, or as an exotic chapter in the history of information security (see [20]), or as a system in need of further improvement (see [1, 16]), or as a contribution to the philosophy of money (see [21]), or in any other manner. Its mere existence justifies writing about Bitcoin. In [5] I have made an attempt to survey the vast and heterogeneous volume of viewpoints on money. I summarize some conclusions from that paper: 1. The main conclusion from [5] which has some bearing on issues around Bitcoin is that I prefer to reserve the phrase virtual money for a concept not remotely similar to Bitcoin. The mere existence in the digital world is not a sufficient criterion for virtuality. Bitcoin seems not to be a virtualized form of any non-virtual money-like commodity. It is far too innovative. 2. Another conclusion of [5] is that in order to write about any any existing money (or near-money) in theoretical terms one needs some formal counterpart to (the units of) that particular money. In particular “Formalbitcoins” enter the picture if one inters to speak or write about hypothetical activities or events involving (equally hypothetical) transaction by means of Bitcoin. Unfortunately the methodology of having a formal substitute for a money as a vehicle for theoretical discussions is not without its own complications. 3. A (unit of) a kind money (for instance EUR, BTC) may serve as a dimension. And just as in physics composed dimensions such as Second/EUR2 are meaningful. 4. Money as featuring inside an organization may differ subtly from money carrying the same name outside that organization. An individual’s understanding of money may depend on his or her role within the organization. Virtual currency is used to refer to an (adapted) perception of money within an organization from the perspective of an employee (or a category of employees). 8
  9. In [8] Bitcoin is considered an informational money (disregarding the complication that it may initially be lacking moneyness) and an attempt is made to map the space of possible informational monies. Yet another way to look at Bitcoin, admittedly quite remote from an ordinary monetary perspective, is that it constitutes a step forward in the development of the non-negative rational numbers (rather than natural numbers) towards being the preferred datatype of for the quantification of monies of exchange.6 2.2 Exclusively Informational Commodities (EXICs) The main proposal of [8] is to consider informational money as a concept for which access has priority over legally backed ownership. With exclusively informational money (EXIM) the proposal of [8] is to denote an informational money for which ownership of a quantity is identical to control (or access) to that quantity. With exclusiveness the absence of any other title than the availability of information is meant. In particular the possibility of existence of legally backed titles of ownership (of EXIM quantities) is refuted. The counterintuitive implication of the notion of an EXIM is that an amount of an informational money (when viewed as an EXIM) cannot be stolen by definition. Change of control (access) is the only way of transfer for an EXIM quantity and a change of control is only problematic if it was effected as a consequence of unacceptable force imposed on the agent who lost control. Using the terminology of [14] it is systematic to speak of an exclusively informational commodity (EXIC), and of a money-like exclusively informational commodity (MLEXIC) if one intends not to commit tot the moneyness of an informational commodity while claiming its exclusively informational status. 2.2.1 Interest on Bitcoin: objections from circulation theory The property of Bitcoin that the amount of monetary units is fixed (or almost fixed) creates a setting where interest can be criticized on the grounds of so-called circulation theory. Circulation theory has a (neo-) Marxist background but its modern shape is rather mathematical in style. Simply told the story is this: suppose all BTC holders hold equal amounts. Now they all lend that amount to other holders in a cyclic fashion. After that step all holders have the same amount but now each of them must pay interest to the previous holder of the amount. Now the means to pay interest must come from somewhere and using new (that is freshly created) money is demonstrably the only available option. On the basis of such arguments, though more sophisticated, circulation theory demonstrates that interest payment and inflation caused by monetary expansion go hand in hand, which then is construed as a weakness of the underlying financial system. Now circulation theorists have to demonstrate that monetary expansion cannot be accounted for by economic growth in order to predict inflation and so on, 6 This viewpoint connects well to my personal long standing interest for the specification and use of the rational numbers as an abstract datatype starting with [13]. Notably the use rational numbers as quantifies come into play only in a context of informational monies. 9
  10. but the case of Bitcoin is simpler . The closed circulation of BTC in the Bitcoin environment seems to provide an argument in circulation theory style against the plausibility of interest payments on large debt positions. It should be stressed that even if the monetary base is constant, circulation theory does not “prove” that some interest may not be paid. Evidently, per unit of time no more than 100% of the money base (say mb ) can be used for the purpose of interest payment, which implies an upperbound (p−1 · mb ) on the total debt position of all participants (given an interest rate p to be paid for all debt per unit of time).7 2.2.2 Borrowing Bitcoin: impossible for an EXIC (and for an MLEXIC) An important conclusion drawn in [8] about an informational money with EXIM status is that besides theft also borrowing and debt is meaningless. It is pointless to qualify the transfer of quantity for an EXIM as borrowing because all transfers of access have the same status. For an EXIM (say Me ) control by agent A of an amount x · Me does not imply the presence of any legal title to that amount which can survive a loss of control by A over (that particular) amount x · Me . An illegal activity by B which allows B to take control over the amount x · Me , and which does so in such a manner that A looses control over the amount x · Me , can be punished on the basis of forbidden actions that constitute a part of the activity. No form of restitution of x · Me to A can be part of a corresponding retaliation directed to B. This state of affairs is different from the common case for so-called tangible commodities, but it is well-conceivable for informational commodities. In [8] care is taken not to classify Bitcoin as an EXIM in order to imply that BTCs cannot be stolen (which might be misconstrued as a viewpoint that stealing Bitcoin should be permitted).8 Instead a thought experiment is carried out where Bitguilder, a hypothetical technical clone of Bitcoin, is introduced and is thought of as having EXIM status. Thinking of Bitcoin as a potential money-like exclusively informational commodity (MLEXIC) rather than as an informational money will not change the picture concerning either the (im)plausibility of lending or the (im)plausibility of interest payment. Doing so merely introduces increased resilience against doubts about the moneyness of the informational commodity at hand. 7 In conventional finance this (kind of ) upperbound may be compromised by a cascading application of the mechanism of fractional reserve banking. Fractional reserve banking may be considered a major mechanism in conventional finance for creating money that may eventually be used for interest payment. In many cases that growth of volume of the amount of money may also be justified by economic growth. That dynamics, with constant prices could be called inflation (an expansion of the economic universe), but instead inflation is used only if the financial universe grows faster than the underlying economic universe, that is the growth of the volume of money cannot be completely justified by a growth of the economy. These considerations become far more complex if changes in the technology of money (such as a gradual transition to the use of informational money) have effects on the speed of circulation of money which are not correlated to dynamics in the size of the economy. 8 If a (quantity of) an informational commodity can be stolen, doing so is an unlawful act of course, but if stealing it is considered a theoretical impossibility, it can’t be unlawful either. 10
  11. 2 .2.3 MLEXIC casting of Bitcoin and gradual transition to IFR compliance If one views Bitcoin as an MLIC (or more precisely as an MLEXIC) then this allows a smooth transition to an IFR compliant system where intermediate development stages allow interestlike payments on Bitcoin denominated debt which are IFR compliant for the trivial reason that (at that stage) Bitcoin is not yet an informational money. In other words one may imagine a growth of the use of Bitcoin through an initial phase where interest payment-like transactions occur while Bitcoin is considered a non-money MLIC (awaiting to become an informational money, or informational currency if one prefers the use of the term currency over the use of the term money). During this initial phase temporary market models (or rather transaction models) may facilitate growth of usage of Bitcoin until a stage is reached from which the application of less favored market models can be replaced by an increased application of “IFR compliant”9 models. After that transition has been made further evolution of Bitcoin to moneyness (informational money instead of MLIC) can be promoted, thus ending in an IFR compliant status without moving through an non-IFR compliant stage. 3 Bitcoin style financial technology for Islamic Finance Having argued that both debt and interest payment are implausible features for an MLEXIC (or EXIM) interpretation of Bitcoin its relevance as a potential tool for Islamic Finance seems to have been demonstrated sufficiently well to justify further research into that connection. Some remarks on the remaining rules of behavior for IFR compliant finance in connection with Bitcoin (or Bitcoin-like technologies under an EXIM perspective) are in order. If clients don’t mislead other clients during transactions the irreversible nature of Bitcoin transfers will not be felt as a handicap. Bitcoin is a technology geared towards realizing donations. After effecting a donation the amount has been fully transferred, no strings attached. Gambling with borrowed money will not happen in a Bitcoin driven context (assuming EXIM status). This limitation is insufficient to eliminate gambling but it significantly reduces opportunities for gambling. The irreversible nature of transactions seems to go well with the true entity requirement. That requirement, however, may constitute a significant impediment for the promotion of Islamic Finance in its own right which needs to be compromised in various ways by introducing flexible views on what constitutes a true entity. What would require rather immediate attention is the trustworthiness of the mining system as well as its compliance with the five principles mentioned above. Before discussing that mater I will first provide some discussion of writing about IFR compliance from an external position. 9 The quotation marks indicate that IFR compliance is meant in a counterfactual way. If the underlying MLIC were in fact an information money (which by assumption it is not) then the transaction model at hand would be IFR compliant. Non-moneyness of the MLIC, however, renders the definition of IFR compliance inapplicable, which suggests a counterfactual treading of IFR compliance in this case. 11
  12. 3 .1 Analyzing IFR compliance: general remarks A most obvious candidate to issue a meaningful statement about IFR compliance of any financial mechanism including Bitcoin in its various stages of development, is the Shariah Board of an Islamic financial institution which offers it services to a general public and which intends to include Bitoin based services in its service portfolio. Such judgments carry authority by definition which is not to say that judgements of a particular Shariah Board cannot be challenged and changed in the course of negotiation and deliberation. I assume that me (or anyone else from outside Islam) writing from an external position about these matters, and about a specific question in particular, constitutes an attempt to predict rather than to prescribe the outcome of the judgment of a relevant Shariah Board when faced with precisely that question.10 Such writing, and its author, can become authoritative in a conventional scientific manner if such predictions turn out to be valid in a relevant majority of cases. This form of writing about particular questions cannot possibly become authoritative in a normative manner, however. That status requires either Shariah Board status, or some other Islamic role permitting the issuing of judgements relevant for other Muslims, of the judgement issuing agent. Nevertheless I conclude that there is room for conceptualization and contemplation of specific questions regarding IFR compliance by non-Islamic authors, provided one accepts the distinction between predictive judgements, which must comply with rules of scientific integrity and the assessment of which is a matter of non-religious social science, and normative judgements which essential require the assumption of certain roles by the issuer(s), the assessment of which essentially involves Islamic scholarly competence. 3.2 Counterfactual IFR compliance of the Bitcoin technology chain I will consider issues of IFR compliance of Bitcoin as if Bitcoin were an informational money, even if it is not not considered that way at the moment, assuming as a general rule that for an MLIC its non-money status (that is MLIC status without moneyness) is not by itself a plausible cause of non-IFR compliance of a component of the its technology chain or of the use of that component. Thus, if one considers Bitcoin to be a non-money MLIC its IFR compliance comes for free assuming metrical implication, but with the counterfactual interpretation (relevant implication) that is not so and its IFR compliance becomes a meaningful assertion which may be in principle considered false rather than true. 3.3 Non-IFR compliance risk analysis In principle a decomposition of the Bitcoin system and its use in a family of components and threads of usage (use cases) must be established that facilitates a modular approach to the question of IFR compliance. Then a risk analysis must look into the risk of misjudgments of modular parts and use cases in terms of their IFR compliance and into the risk of oversight, 10 The line of argument used for such predictions may involve quoting previous judgments about comparable issues by the same or by other Shariah Boards. The line of argument may follow the principles of “Real Islamic Logic”. No argument is binding for subsequent judgements by any Shariah Board, however. 12
  13. that is of failing to imagine problematic use cases and mechanisms because the modular decomposition underestimates the complexity of the system . At this stage I work under the assumption that except for the mining subsystem (counterfactual) IFR-compliance of Bitcoin is unproblematic. This assumption may need further scrutiny, however. 3.4 Potential problems with Bitcoin mining 1 Mining is a problematic aspect of the Bitcoin technology chain: a high eco-footprint, various vulnerabilities against DoS attacks, degrading client participation, nearly insurmountable thresholds for hopeful new miners, and lacking protection of clients against consortium building among miners, to mention some issues. From the perspective of IFR-compliant finance I want to mention two issues: gambling implicit in mining, and transparency of mining. Mining involves a search for a solution to a combinatorial problem. An instance of that problem is automatically generated about each 10 minutes. This search mechanism involves (pseudo-) random generation which is the close to a lottery in a world of deterministic computers. I conclude that mining involves some form of gambling which might be criticized from the perspective of Islamic Finance. One may compare Bitcoin mining to gold mining (which is considered ethically unproblematic in Islam), thereby assuming that a reasonable result in investment is guaranteed (as a rule, that is normally). That comparison makes some sense, but it holds for most lotteries that a participant will get his/her statistical share when participation is sufficiently long. The question is where planned action ends and gambling begins. In risk analysis some authors state that whenever one can calculate the probability of a problem it is not anymore valid to speak of a risk (of occurrence of that specific problem). Perhaps gambling (insofar as it is to be forbidden in IFR) must also be linked exclusively to cases where a probabilistic analysis is unavailable. In gold mining I would claim that some form of competence, earth science etc. enters the picture, but I agree that a complete argument that Bitcoin mining is not IPR compliant needs to demonstrate some clear conceptual difference with gold mining. My second argument (about strategy choice) may be useful for just that purpose. 3.5 Potential problems with Bitcoin mining 2: lotteries versus gambling The reason for Bitcoin to contain a fierce competition between miners four being the first and best at validating a block and incorporating it in the block chain is that the community of users must somehow choose a winner from the miners who submitted a correct block. Distributed lead election is far form easy and the proof of (guess) work mechanism of Bitcoin greatly simplifies the leader election mechanism by asking the newly elected leader to outperform his competitors on a task in such a way that all users can simultaneously assess his success. If only a distributed lottery were feasible no proof of work would be needed and running Bitcoin would be far cheaper. Now it has been brought to my attention by [24] that there is 13
  14. some relevant information about the Islamic permissibility of lotteries and about how gradually a lottery may be turned into a gamble that would not be IFR-compliant . From reliable sources (e.g. http://sunnah.com/search/draw-lots) it follows that a lottery is a permitted instrument for decision taking in principle. A famous example is the American Greencard Lottery (see http://www.luvu4luv.com/Articles_divisa.html).11 The following was also put forward by [24]: a lottery degrades into a gamble if individual participants must play for playing a round and during that round non-winners will loose their money. Now the case of Bitcoin mining is slightly different. Equipment cost are independent of participation with mining rounds and loser of a mining round cannot claim to have lost any money (or investment in hardware and software). Based on this analysis [24] concludes that Bitcoin mining might be considered IFR-compliant. However, taking energy cost into account the picture reverses. The energy cost for Bitcoin a given Bitcoin miner can be accounted per round and a participant to a round must invest energy (almost convertible into money) at least proportional to the search time that the winner will need. Losers of a mining round will unavoidably and immediately the money spent on electricity and cooling for that particular round. Does this argument turn mining into a gamble after all. If energy and cooling is cheap in comparison to hardware then mining might be considered closer to a lottery than to a gamble. But it is more plausible that cost is the other way around and that the saving of mont participating in a round is significant. Then what distinguishes mining from gambling might be the qualitative distinction between money and energy (in Bitcoin practice electricity). But electricity is in today’s practice almost interchangeable with money so that that mining might be considered to be closer to a gamble than to a lottery after all. 3.6 Guesswork involved in search strategy choice However, there might be another way in which one may speak of a gamble implied by Bitcoin mining and that relates to the choice of a search strategy by the miner. A search strategy for a (normal) miner must be so that s/he will not predictably lose against miners with faster equipment. I hold that the choice of a search strategy which deviates sufficiently much of the methods used by other miners may be considered a form of guessing with unpredictable outcome. However, taking into account that this guesswork represents a problematic gamble (from the perspective of IFR-compliance) only if a winning guess requires an investment and a losing guess implies the loss of that same investment, the case for it representing a problematic gamble becomes less convincing. 11 These facts were not taken into account in version 2 of this paper ([7]), while arguably being at (or close to) the core of the issue, though not yet resolving it beyond reasonable doubt. In any case the observations made by [24] prompted a rewrite of this part of the paper. 14
  15. 3 .7 Summary: current Bitcoin mining is not IPR-compliant I conclude that mining resembles a gamble so much that its IPR-compliance might be considered problematic at present. This argument rests on the following assumptions: • For a miner to win a round and to deliver the next block in the blockchain it is essential to win an instance of a competition which resembles a lottery rather than that it requires skill and competence. • Participation to that lottery requires of a miner the use of a non-trivial amount of electricity which need not be consumed if that round is left to other miners. • Electricity is very comparable to money in that it is almost interchangeable. The relation between electricity and a currency is comparable to the relation between two different currencies. 3.8 Redesigning the mining/validation mechanism for IFR-compliance Bitcoin is said to have been designed in such a way that its users need not trust any specific other user. Currently Bitcoin clients (Bitcoin client users) must trust the mining mechanism and the decreasing number of strong miners and independent mining pools sheds doubts on that part of the current implementation of Bitcoin’s promised ideology as expressed in [23]. From the perspective of IFR-compliance it seems meaningful to modify Bitcoin along the following lines (following [8]): 1. Do away with the ideology of distrust: ask clients to trust the community of miners. This requires a modification of the architecture and governance of mining. Insist, however, that no miner, or even no group of say 10 miners, may become a single point of failure. (This step may be needed for Bitcoin as it stands as well.) 2. Accept a formalized split between miners and ordinary clients. 3. Introduce centralized authority for admission to the mining league. 4. Introduce, say, between 100 and 1000 mining agencies, operating independently of oneanother, representing subsets of the relevant population of comparable sizes. Make sure that these agencies do not enter into fraudulent coalitions. 5. Impose innovations that systematically reduce the energy cost (eco-footprint) of mining. 6. Introduce one or more joint Shariah Boards for groups of mining agencies which develop a viewpoint that removes objections against (residues of) gambling as present in current and forthcoming mining technology. Apart from the gambling aspect of mining and the built-in assumption of distrust I don’t see any ethical objections against Bitcoin mining emerging from the IFR requirements. 15
  16. 4 Evolution towards a money In this section we briefly mention some aspects of informational monies that may relate to IPR-compliance in yet unanalyzed ways . 4.1 IFR-compliance lowers functional expectations on monies An Islamic perspective on money produces lower expectations concerning the services that the financial system will provide to society as a whole than a conventional (Western) perspective does. For instance the ambition to strive towards full employment may drive the financial-economic management of a currency area into growth of its monetary base which then creates inflation as collateral damage that one subsequently seeks to remedy by means of increased interest rates. When dispensing of the “weapon” of quantity management the financial/economic management of a currency area may need to look for non-financial interventions for achieving purposes such as a high employment rate.12 4.2 Evolution towards an informational money The evolution of any MLIC (including Bitcoin or a modified version of it) to the status of an informational money (with an emphasis on money) is unpredictable. As its stands this evolution will require many other changes in the case of Bitcoin. If Bitcoin is to coexist with other monies some form of rate-stability must be achieved on the long run and the phenomenon of different monies serving different purposes needs to be well-understood. On the other hand if Bitcoin must drive out other monies in order to evolve to the status of an (informational) money then important changes are needed concerning the design of the portfolio of societal objectives that are to be dealt with by means of financial policies. Remarkably it seems to be the case that such changes are easier to achieve from the perspective of Islamic Finance than from the perspective of a conventional finance. To see this notice that in the Islamic context fewer degrees of freedom are needed to shape money as a policy instrument in the light of the fact that more policy objectives are to be achieved by other means than by manipulating money streams and financial incentives 4.3 Co-existence with other monies Following [8] I suggest that Bitoin-like systems may co-exist just like different monies do nowadays. However MLEXICs will not be limited by the geographical boundaries that are so characteristic for today’s monies. Instead different MLEXICs may serve different user communities, or different purposes, in such a way that a single agent simultaneously uses different MLEXICs. 12 In [8] a preliminary survey is given of the ethical problems that may arise if one seeks to use Bitcoin as the sole replacement of the existing financial system, while assuming that problems nowadays tackled though financial policies will be solved in similar manners in a forthcoming Bitcoin era. 16
  17. It is an interesting question to which extent an IFR-compliant informational money needs to be such that it can take care of the financial transaction requirements of an entire geographic area . in other words: is there an aspic of geographic locality implicit in the notion of Islamic Finance which fails to have been listed in the set of IFR-requirements. 5 Concluding remarks Finally I will have some remarks about financial innovators and I will formulate some speculation on how Bitcoin, or rather Bitcoin-like financial technologies of an EXIM brand may further develop in connection with Islamic Finance. 5.1 Financial innovators: Maududi, Gesell, and Nakamoto In [8] a connection is made between Maududi who is often credited as an originator of Islamic Finance in its modern form, Gesell, who proposed demurrage, a form of personalized and artificial negative interest, and Nakamoto. These names may be considered central figures in the development of unconventional financial systems and methodologies. Interestingly they entertained vastly different views towards interest payment. In each case the lasting impact of the contribution to the development of money cannot yet be appreciated. Financial innovations take many years and giving a convincing assessment of the impact of Nakamoto’s contribution may not be doable within the next 50 years. 5.2 What will happen? What may happen? There is a significant probability (higher than 99% I would guess) that Bitcoin as it is in existence now will disappear from the scene and that some investors will be disappointed. It is mainly the efforts in mining by those who have accumulated BTC stock without selling in between who may loose real money when that happens. The current rate of BTC (around 425 USD while sliding downwards at the time of writing) takes such risks into account. That rate may perhaps be considered a market estimate of exactly that risk. Bitcoin-like technology and what was called the Nakamoto-architecture in [8] is a different story altogether. This technology may well stay with us for a long time (see [19] for a recent statement to that extent, and [26] for a recent opposite opinion) and the risk that Bitcoin represents for conventional finance is not primarily residing in the current Bitcoin infrastructure itself but in the proof that has already been delivered that the web is as good and cheap for transferring (informational) money as it is for the distribution of all other informational commodities. Moreover it has now been proven that with the modest means of an open source community a system can be delivered and maintained that seems to be able to compete with the systems of professional banking. Now it seems to me that either by adopting Bitcoin, and in particular by adopting its perception as an EXIM, while somewhat reorganizing the mining system, or by reengineering the Bitcoin design and its open source software into a newer system with an even better fit to the needs of IFR compliant finance, those who intend to promote IFR compliant financial 17
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