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AMANIE ADVISORS

ETHEREUM FOUNDATION

Ethereum Foundation

The Ethereum Foundation is a non-profit Swiss “Stiftung” (Foundation) registered in Switzerland as “Stiftung Ethereum” (Foundation Ethereum). The Foundation’s mission is to promote and support Ethereum platform and base layer research, development and education to bring decentralized protocols and tools to the world that empower developers to produce next generation decentralized applications and together build a more globally accessible, more free and more trustworthy Internet.

Amanie Advisors

Amanie Advisors has become a leading global brand in the Islamic Finance industry since 2005 with offices strategically located worldwide in leading and emerging markets such as in Malaysia, Dubai, Kazakhstan, Oman, and Morocco. It is a leading ambassador for Islamic finance and often is the first entity in new markets creating a dialogue with the various government and corporate entities. Amanie was founded by Dr. Mohd Daud Bakar, a prominent international Shariah scholar and Shariah entrepreneur, who has developed an innovative model of providing cutting edge Islamic Finance consultancy services on a truly global basis from its hubs in the Dubai International Financial Centre (DIFC) via Amanie Advisors LLC and Kuala Lumpur via Amanie Advisors Sdn Bhd (together ‘Amanie’); making it the first Shariah Advisory firm established as a global company that was also founded and managed by the Shariah scholar himself, thereby providing first- hand Shariah knowledge and expertise. Amanie is teamed by professionals and subject matter experts from various backgrounds such as Shariah, legal, risk, accounting, finance, investment, IT etc., with a strong position to provide holistic advisory services.

Anchoring the firm’s work is the Amanie Shariah Supervisory Board (“SSB”) which provides guidance to the team. The SSB comprises of four globally renowned scholars comprising, Dr. Mohamed Ali Elgari (Saudi Arabia) - Chairman; Dr Mohd Daud Bakar (Malaysia); Dr. Muhammad Amin Ali Qattan (Kuwait); and Dr. Osama Al-Dereai (Qatar).

INTRODUCTION AND PREAMBLE

It has been more than a decade since the naissance of the Bitcoin as the first cryptocurrency in late 2008 which has seen unprecedented series of volatile ups-and-downs in its price. Other cryptocurrencies followed suit with different ideas and purposes; and to a certain extent, with different types of technologies and capabilities as well. Ethereum came into the industry in 2014 when the first whitepaper was published and subsequently went live in 2015, with the goal to create a universal computer, using technology which allows the users to develop decentralized applications and smart contracts on the network – a major milestone in the cryptocurrency and blockchain space. The Ethereum platform is now widely known for hosting most of the Initial Coin Offerings (ICO) projects thus far, which has allowed a wide range of applications to be built on the network. The boom in this aspect over the recent years led to a wider adoption and awareness of cryptocurrency and blockchain in general.

Its native coin, Ether, although designed to serve specific purposes to the network, is sometimes treated in the same way as Bitcoin and other cryptocurrencies by some people with focus only being directed to its daily value and price in the market.

Despite the volatility aspect of cryptocurrencies in relation to their prices, it will be only appropriate and logical to undertake a serious look into the DNA and the very function and behaviour of a cryptocurrency as the market sentiment is not a permanent feature. In the space of the Shariah, the market movement or market risk is not a relevant and impactful element to render something permissible or otherwise, unless it comes under the purview of uncertainty (gharar) or gambling (maysir). While the research in the legal and regulatory aspect is still on going with the majority of jurisdictions remain indecisive over the appropriate regulations to be put in place, the Islamic community is facing uncertainty over the Shariah compliance aspect of the cryptocurrency.

Some scholars and Islamic institutions have attempted to conduct researches on Bitcoin and issued Shariah rulings based on their interpretation and understandings which so far has seen various opinions ranging from favourable approval to outright rejection. However not much attempt has been done on other cryptocurrencies including Ether, although the Ethereum platform itself has the largest global community of developers. This is discouraging to say the least because blockchain has evolved far more beyond Bitcoin with the evolution of the technology going at unprecedented pace with endless potential to disrupt different sort of sectors and industries.

In October 2017, Virgil Griffith, Research Scientist of Ethereum Foundation published an article entitled “Ether is more Halal than Bitcoin”^1 , which has attracted a lot of interests from

(^1) Virgil Griffith, Ether is more Halal than Bitcoin – Link: https://medium.com/@virgilgr/eth-more-halal-than- btc-c2a2ee2d8d3d

the public. In the attempt to understand further the Islamic finance requirement and opinion in relation to cryptocurrency subject especially on Ether, he reached out to Amanie Advisors. After a series of discussion, the parties agreed to start collaboration and doing research together for the purpose of establishing a guideline and parameter to the Islamic finance market on Ether as a cryptocurrency.

Amanie Advisors has had a meeting with the Ethereum Foundation represented by Virgil Griffith, Tju Liang and blockchain advisor, Atif Yaqub in Singapore in July 2018 to discuss among others the scope and objective of research, briefing on the technological aspect of blockchain, Ethereum platform and Ether, and some preliminary Shariah thoughts from Dr. Mohd Daud Bakar who is the Executive Chairman and Member of the Shariah Board of Amanie Advisors, accompanied by Wan Hafizi Halim, a Consultant of Amanie Advisors. Another session of extensive meeting and intensive crash course on blockchain covering mainly Ethereum platform and smart contract technicalities was held in Dubai in September 2018 led by Atif Yaqub.

Dr. Mohd Daud Bakar and Wan Hafizi Halim had also attended the Devcon4 event, the largest annual gathering of Ethereum developers in Prague on 30th^ October to 2nd^ November 2018 where they authored and presented a session titled “Is Ethereum Compatible With Islamic Finance?”. Dr. Mohd Daud Bakar elaborated briefly some of the key issues and provided insights on the subject, as parts of the findings from this research^2. A series of follow up discussions between the parties has taken place since then which has led to the publication of the final outcome in the form of the Shariah white paper.

The paper is structured in two major parts: Part A which covers the technical overview on the subject of cryptography, blockchain, Ethereum platform, Ether and smart contracts, amongst others; and Part B is dedicated for the Shariah analysis based on the research and findings from the technical overview in the earlier Part A.

(^2) The presentation is now accessible in Youtube – Link: https://www.youtube.com/watch?v=RElU07fmecI

a Shariah-compliant asset in Islam by looking at the definition and concept of wealth from Shariah perspective. The next topic will provide brief guidelines of Shariah compliant smart contracts and decentralized applications. The Shariah analysis will also discuss briefly on the mining aspect of the platform, whether the concept of Proof-of-Work protocol and the upcoming Proof-of-Stake are in line with the Shariah principle.

As a general guideline, in Part B – Shariah Analysis, the paper will maintain some Arabic terminologies which are commonly used in the Islamic finance space such as riba, ribawi, gharar, zakat, etc. in italic forms, but a brief definition and description will be provided where required.

PART A – TECHNICAL ANALYSIS

Ether, and to a large extent Ethereum, are the by-products of the technological breakthrough achieved using the blockchain concept combined with the cryptography. Therefore it is logical to discuss first and foremost these subjects before we delve into the subject of Ether.

I. CRYPTOGRAPHY

Ether, as with majority of other cryptocurrencies in the market, is essentially built upon cryptography and blockchain.

Cryptography is the science of communicating securely in the presence of adversaries, who can listen in and even control the communication channel^3. It can be simplified as the method of encryption to disguise and reveal a message (encrypt and decrypt) through complex mathematics. The purpose of encryption is to ensure the message can only be viewed and understood by the recipients and nobody else.

The encryption is the process of converting ordinary information, called plaintext , into unintelligible form called ciphertext. Decryption is the reverse process, in other words, moving from the unintelligible ciphertext back to plaintext. The detailed operation of a cipher is controlled both by the algorithm and in each instance by a “key”. The key is a secret information, which is needed to decrypt the ciphertext^4.

Most of the early work in cryptography was done on the symmetric-key basis as described. A very early example of symmetric- cryptography is commonly known as Caesar’s cipher^5 , which was allegedly used by Julius Caesar to communicate with his generals to protect Roman military secrets. The method involved substituting each letter in the message with another letter obtained by shifting three spaces to the left. For example the letter Z is replaced by W, D is replaced by A, so on and so forth. This information is the secret key to decrypt the message.

Modern cryptography works on the same level and concept, albeit with far greater levels of complexity using advanced mathematical algorithms. The cryptography concept was essentially proposed by Satoshi Nakamoto in his white paper for Bitcoin as a tool and proof to allow any two willing parties to transact directly with each other without the need for a trusted third party^6.

(^3) Pedro Franco , Understanding Bitcoin (2015) , pp. 51. (^4) See Wikipedia, Cryptography – Link: https://en.wikipedia.org/wiki/Cryptography (^5) Pedro Franco, Ibid. 1, pp. 51-52. (^6) Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System – Link: http://www.bitcoin.org/bitcoin.pdf

The Ethereum documents summarize the definition of blockchain as follow:

“A blockchain is a distributed computing architecture where every network node executes and records the same transactions, which are grouped into blocks. Only one block can be added at a time, and every block contains a mathematical proof that verifies that it follows in sequence from the previous block. In this way, the blockchain’s “distributed database” is kept in consensus across the whole network.”^8

The basic concept of a transaction happening on a publicly distributed and decentralized blockchain is illustrated over here:-

Image Source: Blockgeeks^9

III. ETHEREUM

The Ethereum is described in the Ethereum Homestead documentation as follow:-

“Ethereum is an open blockchain platform that lets anyone build and use decentralized applications that run on blockchain technology. Like Bitcoin, no one controls or owns Ethereum

- it is an open-source project built by many people around the world. But unlike the Bitcoin protocol, Ethereum was designed to be adaptable and flexible.”^10

(^8) Ethdocs, What is Ethereum – Link: http://ethdocs.org/en/latest/introduction/what-is-ethereum.html (^9) Blockgeeks, What is Blockchain Technology – Link: https://blockgeeks.com/guides/what-is-blockchain- technology/ (^10) Ethdocs, Ibid.

Ethereum is an “open-source”^11 , public, blockchain based distributed computing platform and operating system featuring smart contract functionality. The purpose of the Ethereum platform is to serve as a base layer upon which people can build a variety of decentralized or sometimes referred to as distributed applications^12 , and smart contracts, so as to enable the full potential of blockchain based applications. More information about smart contract will be described later. Ethereum envisages of becoming the “universal computer” which does not belong to anyone but can be used by everyone.

Ethereum was created by Vitalik Buterin, a programmer from Toronto. He published a white paper in 2013 describing an alternative platform designed for any type of decentralized application developers would want to build^13. His idea received many interests and tractions among the public. Dr Gavin Wood, Co-Founder of Ethereum wrote the Ethereum yellow paper to elaborate the technical details and specification of the platform^14. To get the project off the ground, he and other founders launched a crowdfunding sale in July 2014 where participants purchased Ether which is the Ethereum tokens in what was described as the first Initial Coin Offering (ICO). Raising more than $18m, it was used mainly to fund the project development and now managed by Ethereum Foundation, a non-profit entity based in Switzerland^15.

In the conclusion section of the white paper, it reads:-

The Ethereum protocol was originally conceived as an upgraded version of a cryptocurrency, providing advanced features such as on-blockchain escrow, withdrawal limits, financial contracts, gambling^16 markets and the like via a highly generalized programming language. The Ethereum protocol would not "support" any of the applications directly, but the existence of a Turing-complete programming language means that arbitrary contracts can theoretically be created for any transaction type or application. What is more interesting about Ethereum, however, is that the Ethereum protocol moves far beyond just currency. Protocols around decentralized file storage, decentralized computation and decentralized prediction markets, among dozens of other such concepts, have the potential to substantially increase the

(^11) The term “open-source” refers to the program whose source code is made available for use or modification as users or other developers see fit. An open-source program is usually developed by public collaboration and it is made freely available. Examples of other popular open-source software are Mozilla’s Firefox web browser, PHP scripting language and Bitcoin. (^12) The abbreviation form used in the blockchain community is DApps, but the paper will maintain the standard terminology of decentralized application throughout the document for standardization purpose. (^13) See A Next-Generation Smart Contract and Decentralized Application Platform (Ethereum White Paper) - https://github.com/ethereum/wiki/wiki/White-Paper (^14) See Ethereum: A Secure Decentralized Generalized Transaction Ledger (Ethereum Yellow Paper) - https://ethereum.github.io/yellowpaper/paper.pdf (^15) Coindesk, Who Created Ethereum – Link: https://www.coindesk.com/information/who-created-ethereum/ (^16) Disclaimer: “Gambling” is identified in general context as one of the industries which may benefit from the Ethereum technology according to its founder. It does not mean that it is the main objective or purpose of the creation of Ethereum. The paper will provide further elaboration in Part B on the requirements for a Shariah compliant smart contract which must avoid inter alia the gambling element which is prohibited in the Islamic law.

• Autonomy — Smart contracts will offer the autonomy to the user over the control of the agreement or contract because there is no requirement to have a third-party intermediary.
• Reliable — The concept of decentralization combined with the cryptography will ensure trust to the network because the information and data are encrypted and safely stored in distributed and shared ledger.
• Safety & Security — The user will be assured that the information and transactions conducted with the smart contracts are safe and secured because the network implement complex cryptography that is almost impossible to hack.
• Cost Effective — By replacing the role of intermediaries thanks to the nature of smart contracts which are self-executing and self-validating, entering into a contract or transaction will be more cost effective to the parties.
• Efficiency — Smart contracts will help to save a lot of time, normally wasted on manually processing heaps of paper documents, sending or transporting them to specific places, etc.

Autonomy

Reliable

Safety &Security Efficiency

Cost Effective

V. ETHER

The decentralization nature of blockchain means that the Ethereum platform is not owned or governed by any single authority. It is the main importance of the blockchain which ensures its transparency and security. This functionality however is not free. The system needs a mechanism to provide incentives to the network or nodes which support the platform.

For this reason, Ethereum platform is designed with a reward mechanism by issuing and distributing tokens to the nodes which perform the task of validating and relaying the transactions on the blockchain. The token is called Ether, and the process of validating the transactions on the blockchain is called “mining”, hence the nodes are sometimes referred to as “miners”. More information about mining will be described later.

Ether^18 is the internal currency for the Ethereum platform, and its sole purpose is to compensate miners for verifying the accuracy of the transactions and processing updates on the Ethereum ledger. Because miners are the nodes which perform the task and execute the transactions on the blockchain, it can also be implied that Ether is the token used to fuel or activate the decentralized application or smart contract which generally contains variety of task and actions. Depending on the complexity of a particular decentralized application or smart contract, the number of Ether required will usually be adjusted proportionately.

The compensation amount by operations on the Ethereum platform is priced in units of gas. For example, in each Ethereum transaction, the sender has to specify, "I will offer N units of Ether per gas consumed", and if this amount is accepted by the miners, the transaction is processed. Depending on the value of the Ether at a particular time, the users will have the opportunity to bid different amounts of Ether to pay for their gas requirements accordingly to compensate the miners to perform his transaction.

Gas is the name for the execution fee that senders of transactions need to pay for every operation made on an Ethereum blockchain. The name gas is inspired by the view that this fee acts as cryptofuel, driving the motion of smart contracts^19. Gas costs are paid with small amounts of Ether. Another reason it is called gas although payable in Ether is to ensure a separation between the price of computational work and the highly volatile price of Ether token which is publicly traded on cryptocurrency exchanges^20.

The correlation between Ether and smart contract is better illustrated in the following popular example of a vending machine:-

(^18) The abbreviation form is ETH, but the paper will maintain and use the terminology Ether throughout the document for standardization purpose. (^19) Ethdocs, Account Types, Gas and Transactions – Link: http://ethdocs.org/en/latest/contracts-and- transactions/account-types-gas-and-transactions.html (^20) Chris Dannen, Introducing Ethereum and Solidity (2017), pp. 59.

Issuance of Ether

There are over 100 million Ethers in free circulation to date. At the time of writing the paper, new blocks created and added to the blockchain (or simply called “mined”) will be rewarded with 2 ETH, and the process will take approximately 14 seconds. The issuance of Ether is therefore done automatically by the platform. There is no single authority who “decides” the creation of Ether, nor can any one individual manipulate the network to generate more Ether. There is no maximum cap of Ether, however the issuance protocol is designed based on deflationary concept as to avoid the speculation and price manipulation of Ether. Deflationary in this context means that the number of Ether created per block mined on the blockchain will gradually decrease as the network grows.

Valuation of Ether

As noted above, the Ethereum platform automatically creates new Ether according to the rate of issuance at a particular time. Because the rate of such creation is fixed based on publicly known rules, and because no individual can control or change such rate, no one controls the rate of generation of new Ether. This is as opposed to fiat currencies where the government or central bank controls the money supply and interest rates, therefore indirectly controlling the price of such fiat currency. As a result, the price of Ether is determined solely by supply and demand in the market.

Legal Status of Ether

The US Securities Commission (SEC) recently set out their analysis of how to determine if a cryptocurrency is a security, and their determination that Ether token does not fall into the category of a security. William Hinman, Director, Division of Corporation Finance said during the Yahoo Finance All Markets Summit: Crypto:-

“… And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value.”^22

This is in fact in line with the nature of Ether which functions only within the specific scopes as described earlier on the Ethereum network.

(^22) William Hinman, Digital Asset Transactions: When Howey Met Gary (Plastic) – Link: https://www.sec.gov/news/speech/speech-hinman-

VI. ETHEREUM TOKENS

As discussed earlier, smart contract consists of a set of mechanistic trigger-able operations in the form of IF-THEN statements. Each smart contract is usually represented by a particular token (although this is not always the case because there are smart contracts which do not issue separate tokens) containing the necessary information and instructions as defined by the contract creator. A token is simply a unit of value and a simple representation of a particular smart contract application.

It has to be noted that Ethereum tokens are not the same as Ether. While Ether is the main cryptocurrency of the Ethereum platform and has its specific utilities and functions as described earlier, Ethereum tokens are created at the discretion of the smart contract or the decentralized application developers. Thus, Ethereum tokens may serve different functions and purposes according to specified intended objectives.

There are in general three types of Ethereum tokens which are commonly used in the blockchain, namely equity token, security token and utility token^23.

• Equity token – Also sometimes referred to as asset token, equity token represents ownership of an asset. Such token can be used to replace the concept of company stock where shareholders of a company will hold equity tokens instead of the standard paper contract. Stock trading can be made more accessible to average investor and the corporate governance process can be conducted in a more transparent way using blockchain.
• Security token – According to the US Securities Commission (SEC), a token is classified as a security token if it represents an investment contract. A transaction will be deemed as investment contract if it fulfils the following criteria^24 :- o It is an investment of money; o The investment is in a common enterprise^25 ; and o There is an expectation of profit from the work of the promoters or a third party. A token which meets all the above criteria will be deemed as security token and therefore is subject to all securities laws and regulations.
• Utility token – As the name suggests, utility token refers to a token which serves one or several utilities as defined by the token creator. It usually provides the token holders access to a product or service. The majority of tokens issued today on the Ethereum blockchain fall under the category of utility token.

(^23) Strategic Coin, 3 Types of ICO Token – Link: https://strategiccoin.com/3-types-ico-tokens/ (^24) Blockgeeks, Security Token – Link: https://blockgeeks.com/guides/security-tokens/ (^25) Common enterprise is defined as a horizontal enterprise where the investors pool in their money and assets to invest in a project.

ERC20 is the first standardized form of tokens issued by Ethereum platform. As such, several technical issues and flaws have been discovered by the community of users over the time. There are currently on-going discussions and several efforts to introduce new sets of rules for the issuance of the tokens in the future. Regardless of the standards adopted by the users, the main concept and features of tokens remain intact as discussed earlier.

ERC721 Token

There is another form of token under the category of ERC721 which in brief is a token that is “non-fungible”. This basically means that each token is completely unique and non- interchangeable with other tokens. It is mostly used for smart contract to define ownership of a specific item or object e.g. collectibles, education certificate, a pet, etc. For example, a smart contract which is used as a database of a college degree of its student, or a Shariah endorsement ( fatwa ) as in the case of Islamic finance industry - the token based on ERC is a better type of token where each token can be used as a unique representation of each student’s degree certificate or fatwa.

VII. EXAMPLE OF DECENTRALIZED APPLICATIONS AND TOKENS

At the time of writing the paper, there are around 120,000 smart contracts based on ERC token^28 and around 200 based on ERC721^29. Due to the nature of Ethereum as a fully decentralized public blockchain, anyone can build and deploy smart contract on the platform. There is no centralized platform of repository which tracks or stores all of the information about every decentralized application or smart contract on the blockchain. There are however several independent websites which provide the list of popular decentralized application such as DAppRadar^30 and State of the DApps^31.

For the purpose of this paper and better understanding of how a smart contract works, we will briefly take a look at several smart contracts and tokens as sample case studies.

a. Bancor^32

Bancor is a blockchain protocol that allows users to convert between different ERC tokens directly as opposed to exchanging them on cryptocurrency markets. The project aims to solve the illiquidity as one of the major problems currently faced by the majority of cryptocurrencies including ERC20 tokens. Bancor’s protocol uses smart contract to create Smart Tokens by using its own ERC20 token called Bancor Network Token (BNT). The Smart Token is akin to a central bank holding foreign currency reserves, where in this case it actually holds reserves of all tokens issued based on the ERC20 standard. The Smart Token essentially removes the needs to match the order between buyers and sellers. Instead, the conversion can occur directly through smart contracts on the network.

b. Binance^33

Binance is the biggest cryptocurrency exchange in the world. Binance launched its own ERC20 token called Binance Coin (BNB) in July 2017 as a utility token. BNB allows the token holder to enjoy discounts on the trading fees when trading cryptocurrency on the exchange. Although BNB is primarily a utility token, it is also being traded in the open market and therefore has its own value.

(^28) Etherscan, Token Tracker – Link: https://etherscan.io/tokens (Last accessed: 2/10/2018) (^29) Etherscan, ERC-721 (NFT) Token Tracker – Link: https://etherscan.io/tokens-nft (Last accessed: 2/10/2018) (^30) DappRadar – Link: https://dappradar.com/ (^31) State of the Dapps – Link: https://www.stateofthedapps.com/ (^32) Bancor – Link: https://www.bancor.network/ (^33) Binance – Link: https://www.binance.com/en