Is there Zakat on Bitcoin?

March 6, 2024

6 Min Read

By Mufti Faraz Adam

Introduction

Bitcoin is a digital currency that was created in 2009 by an unknown person or group using the alias Satoshi Nakamoto. Unlike physical currencies such as dollars or euros, Bitcoin is entirely virtual and decentralized. This means no single institution controls Bitcoin and it exists only online. Despite this, Bitcoin functions similarly to traditional currencies and can be used to purchase goods and services from any merchant willing to accept it. But what exactly is Bitcoin and how does it work under the hood? This article aims to explain the technology powering Bitcoin as well as its potential role and function within the global financial system.

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What is Bitcoin?

At its core, Bitcoin is simply a ledger that records transactions between different parties. This ledger, called the blockchain, is distributed across thousands of computers around the world, meaning that there is no central database for hackers to corrupt. The data stored on the blockchain is secured using advanced cryptographic techniques so that the ledger remains tamper-proof. Bitcoin’s value derives from the inability to manipulate or counterfeit the digital records.

Participants in the Bitcoin network are able to generate unique codes known as public-private key pairs using special software. These keys allow users to securely access the funds linked with a Bitcoin address and authorize transfers of the digital currency to others. The public key, as the name suggests, can be freely shared to receive payments, while the private key proves ownership and should be strictly protected. The actual Bitcoin balances are linked to these key pairs and propagate across the peer-to-peer network as transactions take place.

Unlike fiat currencies that are controlled by central banks, new Bitcoins are produced by a mechanism called mining. Miners use specialized computers called “rigs” to compile recent Bitcoin transactions into data structures called blocks. Miners then race to solve an extremely difficult mathematical puzzle to determine the eligible party to add the next block of transaction data to the chain. This process, as designed by Bitcoin’s creator, rewards miners in Bitcoin upon successfully creating blocks, providing economic incentive to secure the network. Over time, the puzzles become progressively harder such that the new Bitcoin supply gradually decelerates and ultimately reaches a limit of 21 million coins. This controlled supply differentiates Bitcoin from national currencies susceptible to inflation resulting from unrestrained printing and management by central authorities.

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How Bitcoin Transactions Work with UTXOs

Each Bitcoin transaction initiates with inputs and outputs representing senders, recipients, and the movement of currency between different addresses. To prevent double-spending of funds, Bitcoin implements a system based on unspent transaction outputs (UTXOs). A UTXO refers to a portion of a Bitcoin amount that is spendable and functions somewhat like a digital coin. Like physical coins, UTXOs have predetermined fixed values and cannot be partially spent, thereby limiting transaction malleability.

When someone owns Bitcoin, what they really possess are UTXOs previously sent to their Bitcoin addresses. These unspent outputs have amounts linked to them that accumulates to the total Bitcoin balance of a user. To initiate transfers, existing UTXOs get specified as transaction inputs, meaning they get consumed and sent elsewhere. As UTXOs have fixed values, one or multiple UTXOs may be required for a particular transaction. If the inputs surpass the intended output value, the difference returns to the sender address as a new UTXO change.

For example, if Bob owns 1BTC comprising two UTXOs of 0.6BTC and 0.4BTC, he has to input one or both these UTXOs to execute a transfer of any quantity. If Bob sends 0.5BTC to Alice, he can input the 0.6BTC UTXO and receive a 0.1BTC UTXO as change. Alice will correspondingly gain a new 0.5BTC UTXO when confirming receipt of funds. In effect, existing UTXOs transform via transactions with recipients getting fresh UTXOs. The UTXO model thus demarcates and traces individual satoshis, the smallest Bitcoin denomination. Destroying inputs and regenerating outputs in each transaction maintains fidelity of transfer and prevents double-allocation of assets, bolstering the integrity and auditability of Bitcoin’s public ledger.

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What is Bitcoin from a Shariah perspective?

Bitcoin is a payment system. From a Shariah perspective, its objective is to function as payment (Thaman). For something to function as payment, it just needs to be:

An asset that is storable and retrievable.
Acceptance as a medium of exchange.

According to Islamic jurists, an asset is something that has utility - that utility is realised by holding and using it, or by spending. Assets like sofas, clocks, and phones provide utility from within themselves. Currencies and money provide utility upon spending, not by holding. It is still the asset itself providing benefit, but this type of benefit is unique with money, that its use case and utility is to function as a medium of exchange.

The Islamic scholars used the word Māl to capture this idea of utility within an asset. Māl is "what is normally desired and can be stored up for the time of need". This definition denotes that the two key criteria for defining Māl in the Hanafis' view are "desirability" and “storability”. The first criterion clearly links Māl to its linguistic root mayl, which means inclination or desire. Mufti Taqi Uthmani describes desirability as something which is beneficial.

Although some Hanafi jurists have stated that Māl must be a physical entity, Mufti Taqi Uthmani dispels this argument and states that the Quran and Sunnah have not explicitly defined Māl, rather, Shariah has left it to the understanding of people. Furthermore, he argues that some Furu’ (substantive laws) in the Hanafi school discuss intangibles as Māl. He thereafter quotes the Fatāwā of late Hanafi jurists which consider electricity and gas as Māl despite being intangible. Thus, intangibles can also be Māl on condition they are desirable and retrievable. It is not necessary for intangible Māl to remain after using, it may be an intangible which is consumed and depleted upon usage. The condition of perpetuity is not required in physical Māl either, hence, food is Māl despite being used by consumption.

In regard to function as a medium of exchange, there is nothing fixed from the Shariah. Anything that people agree and use can function as a payment system and medium of exchange. Of course, people will only use something that naturally can function in this.

Ibn Taymiyyah (d. 728 H) states that the Sharī’ah has not defined any specific condition nor definition for currency and money, and has instead left it to the ‘Urf and understanding of the people. Hence, the Hanafī Fuqahā’ state that assets or commodities become money and currency by Ta’āmul (usage) and Iṣṭilāḥ (common agreement). Imam Ahmad (d.241 H) also opined that currency and money can be identified by the agreement of the people.

Hence, Bitcoin does function as a payment system. It can be used and is being used in parts of the world as a payment system.

Its utility is in use as a payment system, but more importantly, its utility is in the ideas and technical properties that underpin Bitcoin. Bitcoin is a decentralized digital payment system that operates on a peer-to-peer network, emphasizing trust minimization, consensus without authority, and resistance to censorship. Its governance is shaped by the community through a consensus-building process, avoiding centralized control and promoting protocol changes only with user consent. Key to its utility are principles like decentralization, which distributes power to prevent single points of failure or control; pseudonymity, ensuring users can transact without revealing their identities; and an open-source approach, allowing anyone to verify and participate in the network. Bitcoin's design seeks to minimize trust by relying on cryptographic proof, making it a unique form of electronic cash that addresses the pitfalls of traditional currencies by being more secure, transparent, and equitable.