The principle of gharar in cryptocurrency
By: Ibrahim Abu Sammy
Tags: Investing, Islam, Ethics, Bitcoin, Cryptocurrency

WARNING: Blossoms are no guarantee of fruit!

With the recent rally in cryptocurrency prices, questions have been flooding in to Islamic scholars, leading to a new round of fatawa, or legal rulings, by prominent Islamic scholars.

Opinions are divided, with some classically trained scholars seeing it as being not so different than the now largely digital dollar, while others considered that the extreme volatility of the price presented an excessive amount of risk. Some even declared bitcoin haram, or illegal/impermissible in Islamic law. The main principle used to justify this decision was the principle of gharar.

How Much Uncertainty is Too Much?

It’s allowed to invest in an ocean voyage. It’s not allowed to purchase goods before the voyage is complete.

The principle of gharar is usually used to refer to transactions with uncertain or unclear outcomes. Futures contracts are a good example- agreeing to buy agricultural product before the harvest at a predetermined price. In applying this to bitcoin, the assumption is that since so much of the value of bitcoin is speculative, it is unclear what a person is buying and what the outcome of the entire bitcoin venture is going to be.

At least, this is the only way that I can understand that the principle of gharar could be applied to cryptocurrency.

The hadith usually cited as the basis for gharar refers to the selling of birds in the sky, fish in the sea, or unborn animals in the mother’s womb. Clearly this would include futures contracts. Looking at how various scholars interpreted this, we see the Hanafi school, broadly speaking, defined gharar as “that whose consequences are hidden.” Some scholars of the Shafii school of law define it as “something which in its manner and its consequence is hidden.” One Hanbali definition is “that whose consequences are unknown.”

One of the most relevant descriptions for this discussion may be the statement of Ibn Hazm, “Gharar is where the buyer does not know what he bought, or the seller does not know what he sold.”

This would clearly be the case in purchasing fruit before the time of harvest. No one knows what the outcome of the harvest will be. It could be a large amount of high quality fruit, or a small amount of completely inedible fruit.

If we consider this in the case of bitcoin or more broadly cryptocurrency, it could definitely be argued that many people investing in bitcoin are engaging in gharar transactions. They may not really know what it is they are buying, and they may be motivated only by the hope of quick profits.

If Blockchains Were Engines…

Let’s say there’s a village exisiting in total isolation from the outside world. This village has never had a combustion engine before. Then one day someone shows up with the plans for a combustion engine, and builds it, and starts to use it to run a water pump. Everyone is amazed, and the water pump service turns out to be highly profitable. The people who helped the first person build the engine become very wealthy.

Then people start saying that engines can be used for other things rather than just water pumps- they could be used for things like chainsaws, tractors, motorcycles, airplanes, or even to run multiple water pumps rather than just one water pump with modifications.

The result is that the value of the one functioning engine in the village skyrockets- not because of the actual value of the engine for its current use powering water pumps, but because of speculation about the future uses.

Some claims may be very based in fact. Let’s say one villager has a design for a car, and real concrete plans for implementing it. Another villager may have a design for a “rain cloud maker” powered by an engine that has complicated schematics that actually don’t make any sense when you deeply analyze them- but some villagers are so impressed by the idea that they agree to help the man build it with their resources. The man then allots himself a hefty salary on the development team of the impossible “rain cloud maker” project.

Obviously, this scenario is taking a technology we understand, the combustion engine, and comparing it to one we don’t fully understand, blockchain.

What this is practically meant to illustrate is that whether or not a transaction falls into the category of gharar is directly related to the level of understanding of the person investing. This is not as clean and black and white as we might hope, but I don’t believe the presence of doubtful issues in the cryptocurrency space means that it should be avoided entirely. The value of bitcoin is highly driven by speculation, but essentially, bitcoin is similar to a stock in that it is a joint venture that is open to anyone.

The value of bitcoin is determined largely by the contributions of the members of the bitcoin community, but bitcoin itself has proven uses that are entirely independent of its speculative value. Furthermore, purchasing a cryptocurrency increases its value, which in a way is a contribution to the development team of that cryptocurrency- this is very different than simply betting on the future value of a harvest. Buying cryptocurrency is a very real way to support the community developing a new technology. It thus has very real utility to society, unlike pure gharar transactions.

Knowledge is Key

This underscores the importance of cryptocurrency education from the Islamic perspective- the difference between investing in bitcoin being halal (legal in Islamic jurisprudence) or not could be directly related to the level of knowledge of the person investing. This is because the essence of a gharar transaction is that the buyer does not know what they are buying.

In the example of a combustion engine, someone who does not understand it could look at it and say “Why are people making such a fuss over this strange looking hunk of metal? I’ve seen similar quantities of metal for much cheaper prices.” If someone were then to say “You can make something that can lift heavy objects for you with this, and maybe you turn lead into gold with it,” if the person was to purchase it with the hope that it could be used to manufacture gold, the value would be much higher, because creating gold out of lead would have much quicker and bigger gains than simply lifting heavy objects. If they were to really assess the dynamic of it and determine that it can be used to lift heavy objects, but not to manufacture gold, the value would be lower, but still much higher than a piece of metal of similar weight with no functionality as an engine.

This is another beautiful illustration of the wisdom of Islam, and how the legislation is designed with the well being of humans in mind.

Hard Times Make Strong People, and Strong People Make Easy Times

With Bitcoin, it was very clear from the beginning that the people who understood what Bitcoin was were the ones that supported stability of the price. Each time there was a rally, a bunch of get-rich-quickers would show up and start buying into it even though they didn’t know what it was. Then some negative news story would come out, and the price would crash, and all of the people who didn’t understand what it was would panic and sell, resulting in the price crashing even more and leading to a lot of people losing a lot of money.

However, the people who did understand it would patiently hold their coins, and speak as the voice of reason in the community, explaining why the fundamentals of bitcoin were still sound, and why it was, in fact, undervalued.

Gradually, this group would lead to price stability, and the prices would level out until the next rally.

Essentially, the strongest fatawa (Islamic legal rulings) on bitcoin have stated investing in bitcoin is allowed if you belong to the people who “get it”, but not allowed if you are one of the “get-rich-quick” types that doesn’t get it.

If Muslims as well as non-Muslims could follow this guidance, it would lead to a much healthier cryptocurrency ecosystem overall.