Tokenizing Assets in Light of Hadith
By: Ibrahim Abu Sammy
Tags: Bitcoin, Sharia, Cryptocurrency, Tokenization, Islam

One of the first objections that comes up when examining the resistance to cryptocurrency among the Muslim community relates to one of the core injunctions of transactions in finance- the necessity of the presence of the physical object being bought and sold.

The Prophet (blessings and peace of Allah be upon him) said to Hakeem ibn Hizaam: “Do not sell that which you do not possess.”

There is a hadith in Sahih Muslim where the Prophet, blessings and peace of Allah be upon him, states, “There is no riba in hand-to-hand [spot] transactions.”

It was narrated from Tawoos from Ibn ‘Abbaas (may Allah be pleased with him) that the Messenger of Allah (blessings and peace of Allah be upon him) forbade selling foodstuff until one has received it in full. I [the narrator] said to Ibn ‘Abbaas: Why is that? He said: Because they are exchanging dirhams for dirhams, but the delivery of food is delayed?

If we look at this legislation, we see that it closes a major window to the distortion of value.

On the most obvious level, this is because the quality of the goods may vary, and the buyer is purchasing without examining the goods. The quality of gold, silver, livestock, or food can vary significantly, and if the seller does not know precisely what he is selling, this could lead to conflict as the buyer feels that the goods have been misrepresented.

An Ounce of Prevention is Worth a Pound of Cure

An extension of the prohibition, however, is the prohibition of the fractional reserve system as a whole. Fractional reserve banking started when gold smiths in medieval Europe started to issue certificates of gold in excess of their actual gold reserves.

Fiat currency was an outgrowth of this system, where the actual gold reserves declined so much that the link to the underlying asset was broken entirely.

As if this wasn’t ridiculous enough, banks now dilute the supply of their fiat currency, meaning the actual money we use is a fraction of a fraction of its origin.

Needless to say, this is completely contrary to the aim of Islam. This development also plays a major role in the bloody conflicts of the twentieth century, where secularist governments alternately representing Communism, Fascism, and Democratic Capitalism caused the deaths of an estimated 50–100 million, making it the most violent period of human history, by a significant margin.

It is worth noting that these conflicts caused by secularists were not only the most violent in terms of overall numbers, but also as a percentage of the earths population at the time.

If we consider prophethood to be characterized by prescience, then this preemption of the catastrophic fractional reserve and fiat systems is one more powerful proof in the virtually endless list of proofs of the authenticity of the prophethood of Mohammed (peace and blessings of Allah be upon him).

What Does this Mean for Tokenized Assets?

In short, tokenizing an asset means that its ownership is tied to a cryptographic token. For example, a fixed number of tokens are issued on a cryptographic network, and each token is agreed by some central authority to represent one gram of gold. This was the strategy of blockchain startup OneGram.

The problem with this model is essentially that it directly contradicts the injunction from the hadith discussed above- if you are to buy or sell gold, then the transaction must be on the spot.

In the case of OneGram, we only have the promise of the company that issued the gold tokens to enforce what is essentially a contract. This contract states that the owner of one digital token is entitled to receive one gram of gold from the company. This opens a huge box of moral hazard, as the company behind OneGram has every incentive to misreport the actual amount of gold in their possession, and as long as no one suspects anything, they would probably get away with it too.

Even if they mean well, what happens if there is some kind of political disturbance? The network is global, but let’s say the company is based in Dubai and the gold reserves are in the custody of an auditing firm in Australia, and a diplomatic spat leads to the seizure of the reserves as sanctions are slapped on the UAE for some reason or another.

It wouldn’t even have to happen- just a rumor that something similar might happen could destroy the value of the token in a matter of minutes, leading to huge losses. Something similar could never happen with real gold, so as with most legislation in Islam, we see that Islamic law protects the well being of all.

Also as with most legislation in sharia, the reasoning behind any ruling is certainly far more manifold than the reasons that can be explored here, so it should be sufficient to recognize the prohibition in the hadith- in spite of OneGram being billed as the “world’s first sharia compliant cryptocurrency.”

The Distinction Between Movable and Immovable

There is a distinction in fiqh between movable and immovable property, and obviously the requirement for purchases taking place hand to hand do not apply in this case- rather, the ownership being transferred with witnesses or the legal conventions of the land are sufficient to transfer the ownership of the property.

Generally this applies to land, houses, trees, or other goods that can either not be moved, or that are highly impractical to move.

The implication here for cryptocurrency is important, since it could imply that tokenized real estate would be permissible in Islamic law.

This is actually a really exciting prospect, because it could be a means for escaping the clearly haram fiat currency currently used by the vast majority of world’s Muslims under the excuse of obligation (ikrah), while at the same time retaining the properties necessary for international trade.

It would also have greater utility than gold, because it could be managed by a trust, (waqf).

In this way, a property can be legally dedicated to pay its profits into a trust account. When the rent is collected, a portion is set aside to pay for the maintenance of the property, while the rest would be payed into an account. If the ownership of the property is represented by tokens, it is possible to track the location of the tokens and distribute the proceeds of the rent to each token owner.

True Stablecoins

This is not to say that there is not a place for floating cryptocurrencies. If we look at the sharia requirement to actually possess something that you buy or sell, we see that a currency like Bitcoin fulfills this definition very well. However, there are many situations where volatility is problematic, so it is not practical to keep all wealth in Bitcoin all the time.

The solution to this volatility so far has been stablecoins pegged to fiat. Yes, this does give an illusion of stability, but you are tethering yourself to a sick and dying currency. A real asset, like a grove of date palms, however, is much more likely to hold its value than paper money.

Tokenization represents a major opportunity from an Islamic perspective. For the first time in history, the possibility may exist to transact with real goods while still maintaining the advantages of instantaneous electronic transfers.