My purpose here is not to either promote or deride cryptocurrencies, and it is certainly not to give investment advice. There are plenty of other places on the internet where you can get all of these things. Instead, I designed this as a practical guide for those contemplating dipping their toes into this world and wondered about the Islamic implications or already have cryptocurrency assets. It is structured as “frequently asked questions” so that it might be helpful to people of various knowledge levels (if you have more knowledge, skip over the questions that seem elementary. Because cryptocurrencies are still not common knowledge, I am assuming no knowledge in this FAQ.
What is a cryptocurrency?
A cryptocurrency (often crypto for short) like Bitcoin or Ethereum, two of the most popular ones at this point, is a kind of digital token representing a value that you can trade online (or on a street corner with paper bags). Of course, this assumes the existence of people willing to trade that specific cryptocurrency. Currencies that most of us are familiar with are known as “fiat currencies”-this refers to the fact that governments create money by “fiat.” Non-governmental entities (individual people or companies) make cryptocurrencies through a process of “mining” or “staking.”
Cryptocurrencies can vary based on whatever theory is that justifies their existence. This theory may change over time. Many of them have some unique story associated with them that attracts people to buy them. They can also be speculative bubbles built on hype.
Why do people own cryptocurrencies?
Their increased popularity means many people will own them to make money. However, there is also an ideological aspect to ownership. An anonymous person created bitcoin by writing a white paper in the wake of the 2008 financial crisis. It is the notion that governments and central banks do not have the best interest of ordinary people in mind.
Bitcoin is perhaps the cryptocurrency most associated with ideology. Bitcoin also has the property of being “deflationary” because supply is limited by design. Dollars are by their nature “inflationary.” The Federal Reserve, which issues dollars, keeps making more of them. The more dollars there are, the less valuable each dollar is. Other cryptocurrencies may have different use cases, including programing and authentication-related services.
Are cryptocurrencies halal?
Sh. Mustafa Umar states that as a general rule, owning these assets is permissible, just in the same way that you might own currencies from other countries. What makes it impermissible is when it becomes gambling. It appears this goes to your thesis for holding these assets in the first place. If your attitude is that you may lose everything you invested or get rich quickly, and the reason for why one thing would happen and not another cannot is something you cannot articulate by anything more than luck, it starts to look a lot like gambling. Day trading of various assets often fits this bill.
How does cryptocurrency get stored?
Cryptocurrencies are usually stored on a “blockchain.” A blockchain is a giant public ledger that has no central server or control. No person can actually “possess” cryptocurrencies; what you can have, though, are the “private keys.” It is nearly impossible to decipher the private key through hacking, but it is easy for the blockchain to verify it. Anyone who wants to look at the public ledger can see money moving around from one place to another, but they will usually not know who the parties are. Some investigators can figure it out once they know where to start, however.
You can store private keys in online and offline digital wallets or even on pieces of paper. Crypto evangelists will often tell you that unless you possess the keys, it is not yours. Many people have lost enormous sums of money by losing their private keys or having it falling into the hands a hacker or subject to a government seizure. Of course, if you keep your keys in a safe, those are also subject to theft or government seizure. Nothing is entirely secure.
But there is no FDIC or SIPC insurance when I buy a cryptocurrency?
None. These are attractive assets for thieves and difficult to recover if a thief gets them. Insurance is available in the private markets though some may find it prohibitively expensive.
How is crypto different from owning stocks?
It is vastly different other than the fact that you can experience both gains and losses. Stocks represent ownership in a company. They employ people and report their profits and losses from selling things or providing services.
Publicly traded companies can sell more stock in the public markets if they want to raise more money. Most of the time, you hold stocks “in street name” through a brokerage. However, it is technically possible to store stock certificates in a safe.
A currency (including crypto) is not a company but a medium of exchange. Like any medium of exchange, it is valuable because people think it is. There are no buildings, factories that make useful things or services. Crypto can appreciate or depreciate based on demand and supply at any given moment. Some people also own “stable coins”- tied to the US dollar’s value or something else.
There is a wrinkle in this description because people do earn money by holding specific cryptocurrencies. When you have common stocks, you could earn income through dividends. If you own dollars and put them in the bank, you can earn interest. With cryptocurrencies, you can (but do not necessarily) earn “rewards.” “Rewards” is a concept different from both dividends and interest. There is also the possibility of making transaction fees.
What are Rewards?
Cryptocurrencies offer rewards for participants in the system. The first is something called “proof of work” (POW), while another is called “proof of stake” (POS). There are a variety of different cryptocurrencies and many ways to innovate, however. A cryptocurrency like bitcoin is created through a resource-intensive process known as “mining,” which involves computers solving puzzles. The POW allows for creating new bitcoins on the blockchain, rewarded to the person or company that solves this puzzle. Proof of Stake (POS) involves a protocol where certain coins are “staked” to create new coins. There are also transaction fees when people buy and sell currencies.
So, People Can Earn Income Just Holding Crypto?
Price appreciation is not the only way for people to profit from crypto assets. Many report earnings greater than interest rates at banks, bonds or stock dividends, or real estate rental income. This income is usually not interest-based, though there are opportunities to earn and pay interest in crypto.
So How Do People Hold the Keys to their Cryptocurrencies?
Many people hold cryptocurrencies on an exchange; popular ones include Coinbase and RobinHood, though there are many others. While many of these organizations (including the two I just named) are based in the United States, several organizations are not. Many prefer doing business outside of the United States because they get better terms and prefer the lack of regulations.
It is also common to hold keys in “wallets.” These are usually devices that contain information and verify transactions. Wallets can be offline or online software (“cold” or “hot”).
There are also indirect ways for people to benefit from crypto in their traditional brokerage account. People hold these in a brokerage account like any stock.
What is the Best Way to Hold Cryptocurrencies?
There is no general advice here. The direction of experts in the field tends to be to keep your keys in a cold wallet. There can be no bank levies, and it is supposedly impervious to computer hackers (a common way for some to have lost their crypto). I can also say for a lot of people keeping your keys can be a horrible idea. Every individual will need to make their own choices here. But many individuals have lost significant amounts of money just by misplacing passwords or becoming the victim of elder abuse. Some people may be better off leaving their funds in an insured crypto wallet. It depends on what gives you peace of mind about your funds.
How Does Islamic Estate Planning Work for Crypto Assets?
Your successors are supposed to get cryptocurrencies consistent with the Islamic Rules of Inheritance. So, you will need an Islamic Living Trust. The Trustee of your living trust should be empowered to access your crypto assets. If you hold cryptocurrencies in a “cold wallet,” then this person will need to have a way to access your pin or password when you have passed away or have become incapacitated.
If an outside company holds your keys, it should work similarly to a brokerage account. But, unfortunately, many of these companies do not support estate planning the way brokerages do. Indeed, many non-US companies and even some US-based companies do not seem to contemplate that their clients will die and someone needs to access the cryptocurrencies. So instead, you can save a username and password and make sure the person appointed as your successor has access to it. This is not ideal. It is best not doing business with a company that controls your crypto and may not give it to your family after you pass away. It is worse if no US Judge has the power to make them.
If you don’t hold crypto keys yourself, at least make sure it is someone you trust, and that there is a process to get it to your successors.
How do I prevent a Successor Trustee from stealing Crypto from Beneficiaries?
Realistically, it is hard to prevent a successor Trustee from stealing anything. You have them in that position because you trust them. However, it is possible to take precautions. The measures may include naming multiple simultaneous trustees, developing protocols, including regular accounting and documentation.
How Do Trust Companies that Manage Irrevocable Trusts Handle Crypto Assets?
Trust companies have been developing their own protocols for handling such assets for people who have an irrevocable trust managed by a professional trustee. Unfortunately, at this juncture, some trust companies are not equipped to handle these assets. I anticipate this will change soon enough.
How Do We Pay Zakat on Crypto?
Unlike, say, business assets, zakat on cryptocurrency assets is straightforward. Muslims pay 2.5% of whatever you own each year. So, your crypto is a virtual pile of money, and you treat it as such. You can typically pay zakat with crypto using cryptocurrencies as many charities now have the means to accept this form of payment, and if they do not yet, it is easy to get. Crypto is also a great way to give non-zakat charity and use for your Islamic Charitable Planning.
To go over the process of Islamic Estate Planning and to schedule a 15-minute zoom call with Ahmed Shaikh, you can click here.