Crypto, Futures, and Leverage
5 mins read
1) Trading Currencies is Allowed, but they must be Spot transactions
Sarf (currency exchange) is defined as the exchange of money, including like-for-like (e.g., gold for gold) and non-like (e.g., gold for silver) transactions, traditionally exemplified by dinars and dirhams in the Prophetic era. This was expanded over time to include anything used in place of precious metals, such as representative and Fiat currencies and now cryptocurrencies. If you argue that should not be the case, ask yourself "Are these new currencies exempt from Zakat? Would I loan them at interest?" If you answered no to these questions, then you have to treat them like you would gold and silver.
The legality of sarf is based on the teachings of Prophet Muhammad ﷺ who said, as narrated from Abu Sa’id in Muslim and others
"... (Buying and selling) gold for gold, silver for silver, wheat for wheat, dates for dates, grapes with grapes; like for like, hand to hand (spot), this for that. If the type is different, then sell it according to your wishes on spot terms."
This applies to precious metals, currencies, and staple goods. All other assets are not included in this.
This hadith mandates immediate, equal exchanges for similar types and permits varied terms for different types. Sarf transactions become Riba when these specific conditions are not fulfilled: equal weight for similar goods, immediate exchange without delay, and the immediate transfer of goods to ensure possession.
These guidelines aim to prevent Riba and ensure fairness in transactions, preventing arbitrage on price differences that only one side can benefit from and preventing disputes over transactions.
Therefore every currency transaction must be a spot transaction in order to be permitted Islamically.
2) Impermissibility of Currency Futures and Forwards
Currency futures are contracts traded that lock in the exchange rate for the purchase or sale of a currency on a future date. They apply to all currency, including crypto. Let's use BTC as an example.
If you want to speculate on the price of Bitcoin a month from now, without having to actually hold the cryptocurrency you'd use Bitcoin futures. Most people just trade the futures to arbitrage and make money, but they can be settled in cash or, less commonly, in the actual Bitcoin.
- Buy a Bitcoin futures contract at $40,000 expecting a price rise.
- If Bitcoin's price reaches $50,000 at settlement then either
- a) Cash Settlement: Profit from the $10,000 difference per Bitcoin.
- b) Physical Delivery: Buy Bitcoin at $40,000 and hold or potentially sell at $50,000, realizing a profit.
- If Bitcoin's price reaches $50,000 at settlement then either
- a) Cash Settlement: loss from the $10,000 difference per Bitcoin.
- b) Physical Delivery: Buy Bitcoin at $40,000 and hold at a loss because it is only worth $30,000
So are currency futures permitted? No, they are not. Why? Several reasons:
- The use of futures in currency violates both conditions for valid currency exchange.
- There is no spot transaction and no actual exchange of counter values.
- Essentially a future is a contract for a commitment to exchange in the future, and thus creates a liability that should have been spot, turning it into a debt.
- Trading in arrears (owed debt for debt) is impermissible by consensus of all scholars.
- Speculation in currency and precious metals causes volatility, which negates the wisdom behind currency being a stable means for value transfer.
3) Using Leverage in Trade
Leverage refers to the use of borrowed funds to increase one's trading position beyond what would be available from their cash balance alone. It is expressed as a ratio, such as 2:1, 10:1, or 100:1, indicating how much more a trader can invest in the market compared to their own capital. For example, a leverage ratio of 10:1 means that for every $1 of the trader's own capital, they can control a $10 investment in the market.
Because these funds are borrowed, leverage is simply a loan that amplifies both potential profits and losses. It acts as a double-edged sword, allowing you to amplify potential gains with a fraction of your actual capital. There are two ways people access currency markets (crypto included): Direct Market Access (DMA) and Market Maker CFD models. Any trading has huge amounts of risk and therefore must be avoided completely when Haram and if allowed only used by experienced traders.
With DMA, you directly access live market prices and pay commissions in exchange for complete control. Market Maker CFDs differ as you trade contracts directly with your broker, bypassing the live market. Here, leverage comes embedded in the wider bid-ask spread, meaning you pay a premium for convenience. While your broker sets the margin requirements and earns fees, you don't have direct market access.
Let’s look at how the leverage amplifies your money
Scenario 1: 1% Profit with Leverage
Imagine you deposit $1000 and use 5x leverage, giving you control over a €5000 position (assuming an exchange rate of 1.2). Let's say EUR/USD increases by 1% from 1.20 to 1.212.
- Position profit: With a 1% increase, your €5000 position earns €50 (5000 * 0.01).
- Actual profit: However, remember you only used a $1000 deposit (converted to €1200 at the exchange rate). So, your actual profit is (€50 / €5000) * €1200 = €12.
Scenario 2: 1% Loss with Leverage
Now, let's say EUR/USD decreases by 1% from 1.20 to 1.188.
- Position loss: The 1% decrease results in a €50 loss on your €5000 position.
- Margin impact: Since your deposit (€1200) acts as the margin, this €50 loss wipes out your entire deposit. Additionally, you might owe your broker the remaining €48 (50 - 12) depending on their policy.
Key takeaway: Leverage magnifies your profit but also you losses, and a small dip can deplete your deposit and lead to further debt. If you don’t have certain protections in place, you can end up owing more than you actually deposited if the market drop too fast.
So is Leverage Permitted?
Leverage in currency trading can involve borrowing funds from your broker (like in DMA accounts) or using embedded leverage within contracts (like CFDs). While brokers benefit from interest rates and fees associated with leverage, their primary motivation is often to attract more clients and increase trading volume, generating higher overall revenue.
Why would a broker loan you something? Is it altruism and the goodness of his heart?
In DMA the broker is loaning you directing and charing an explicit interest rate on top of that loan. This is the definition of Riba and there is no other way to characterize it. In the CFD model, the money he would have made by charging you an interest rate on top of the loan is embedded in the buy-ask spread. You’re only being loaned “leverage” because the broker placed a premium on top of what the market rates are. That premium may be a spread so small it isn't even noticeable, but through trade volume they are able to make significant amounts of money.
Both of these methods contravene a well known prohibition, the Prophet forbidding “a sale with a loan.” This hadith was narrated by Malik in his Muwatta’ and Ahmad in his Musnad and is authentic. What this means is that regular transactions should not become a means for embedding a loan and making more money off the transaction that normal.
Here’s a summary of what is allowed and not allowed
- Spot transactions: Immediate exchange of like currencies (e.g., USD for USD) or different currencies at current market rates.
- Currency futures: Contracts locking in exchange rates for future delivery, violating spot transaction requirement.
- Leverage: Using borrowed funds to increase trading positions, creating debt and resembling interest (riba).
Reasons for Impermissibility:
- Futures and leverage violate the requirement for immediate exchange in spot transactions.
- Leverage involves borrowing or debt, which is prohibited in currency and precious metals trading.
- Speculation using futures and leverage destabilizes currencies and goes against their function as stable means of value transfer.
- Leverage amplifies both profits and losses, leading to potentially excessive risks and debt.
Be Careful and Avoid Haram
This applies to all kinds of currency, including digital currencies like cryptocurrencies. Trading always comes with risks, and the greatest risk comes from involving oneself in Haram in attempt to make profit. The main points to remember are to stick to spot transactions in currency trading, steering clear of futures, using leverage, or engaging in any form of borrowing. It's vital to be aware of the risks associated with trading and to conduct your trading activities responsibly, making sure they are ethical and in accordance with Islamic values.
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