Shariah Perspective on Stablecoins

 

Stablecoins have emerged as a significant innovation in the cryptocurrency ecosystem, offering a bridge between the volatility of traditional cryptocurrencies and the stability of fiat currencies. This article explores the concept of stablecoins and examines their permissibility from an Islamic finance perspective, including the Shariah views on holding stablecoins. 

What are Stablecoins?

Types of Stablecoins

There are several types of stablecoins, each with different implications from a Shariah standpoint:

1. Fiat-backed stablecoins: These are backed 1:1 by reserves of fiat currency, such as USD or EUR. Examples include Tether (USDT) and USD Coin (USDC).
2. Commodity-backed stablecoins: Backed by physical assets like gold or silver. Examples include Pax Gold (PAXG) and Tether Gold (XAUT).
3. Crypto-collateralized stablecoins: Backed by other cryptocurrencies, often over-collateralized to account for volatility. DAI is a prominent example.
4. Algorithmic stablecoins: Use algorithms to control supply and maintain a peg, without direct asset backing. Examples include TerraUSD (UST). 

Shariah Perspective on Stablecoins

From an Islamic finance perspective, several key issues need to be addressed when evaluating stablecoins:

• Asset Backing and Tangible Value

Islamic scholars generally view fiat-backed and commodity-backed stablecoins more favorably, as they are backed by tangible assets. This aligns with the Islamic principle that currency should have intrinsic value. Gold-backed stablecoins, in particular, may be seen as closer to the concept of sound money in Islamic economics. Fiat-backed stablecoins are generally considered permissible, fully backed by the underlying currency or not, as long as this information is transparently disclosed to the users. 

• Stability and Gharar

Stablecoins' aim to reduce volatility aligns with Islamic finance principles that discourage excessive uncertainty (gharar) in transactions. However, the effectiveness of different stablecoin mechanisms in maintaining stability varies, which may impact their Shariah compliance.

• Interest and Riba’

Some stablecoin protocols involve interest-bearing mechanisms or yield generation, which can be problematic from an Islamic perspective due to the prohibition of riba’ (usury). Muslims should exercise caution when participating in stablecoin systems that involve interest payments. A stablecoin should not include interest-bearing mechanisms in its structure. Stablecoins that might involve interest are those backed by ribawi items, such as fiat-backed stablecoins.

This is in line with the SAC SC view on digital currency. If a digital currency is backed by ribawi items like gold, silver, or currency, it is categorized as a currency from a Shariah perspective. As a result, trading such digital currency is subject to the principles of bai’ al-sarf.

On the other hand, digital currency that is based on technology without any underlying asset, such as commodity-backed, crypto-collateralized, and algorithmic stablecoins, is not considered a currency from a Shariah perspective. Such digital currency is not categorized as a ribawi item, and therefore, trading it is not subject to the principles of bai’ al-sarf.

• Transparency and Governance

Islamic finance emphasizes transparency and ethical governance. Stablecoins with clear, auditable reserves and transparent governance structures are more likely to be viewed favorably from a Shariah perspective. The issuer must provide clear information about the backing assets and their management.

Holding Stablecoins: Shariah Considerations

Stablecoins can be held, provided they meet the criteria of an ‘uqud. They can be permissible under specific conditions:

1. Permissible if assets or any RWA backs the stablecoins. If it is not 100% backed by any of those, then the ratio should be disclosed. 
2. The backing assets should be Shariah-compliant (e.g., not involving prohibited industries).
3. The holder should have the right to redeem the stablecoin for the underlying asset.

It's important to note that while holding stablecoins may be permissible, using them for speculative trading or in ways that resemble gambling would not be considered Shariah-compliant. It depends on how users utilize them.

Conclusion

While stablecoins offer potential benefits in terms of stability and efficiency in the crypto ecosystem, their Shariah compliance depends on various factors including their backing mechanism, transparency, and adherence to Islamic financial principles. Muslims interested in using or investing in stablecoins should carefully evaluate each project's structure and consult with knowledgeable Islamic finance experts.