Islamic Finance : A Benefit For Blockchains?

The promise of crypto-currency and their underlying blockchain technology offer a completely radical view on money and exchange. The combination re-introduces the notion that currency can be of any value that we find ourselves collectively agreeing upon. In addition to that, the rapid exploitation of the technology presents us with another fundamental aspect of finance.

The Islamic Gift Economy (IGE) is defined as an economic network that operates on the principles of cooperation, mutual consent and risk sharing. The IGE’s financing principles are rooted in the same fundamental philosophies that define the Islamic Finance Industry, which prohibits interest, speculation and gambling. Inotherwords, the IGE promotes financing that encourages partnerships and invest in “real” economic assets. In Islam; money is defined as any commodity with intrinsic value. Gold is an example of such a commodity, where its value is backed by the theoretical scarcity of supply and its current international market demand. Its prices and supply are not set by any one individual or entity, which also made it an international standard. This was abandoned in 1971 when the Bretton Woods System gave way to the existing centrally issued fractional reserve based currencies of today. The Fiat currencies that we know are therefore predominantly backed by speculation and credit, which means it is ultimately backed by interest.

In its current form, the Malaysian Islamic Banking and Finance ecosystem operates within an environment that consists of the Central Bank and the Securities Commission, as well as the local state governments which regulate Zakat. In addition there are the various Waqf regulatory bodies that are governed by independent states and their relevant local religious authorities. Sukuk has traditionally been Malaysia’s leading islamic financial vehicle, which commonly offers three models. Asset-backed, asset-based, or credit-based Sukuk categorisations have been established as standards.

Tokenisation (otherwise known in the traditional finance industry as Securitisation) – is making it possible for individuals to digitise a representation of any kind of assets. Regardless of whether they then have any economic value in their newfound digital form; tokens can be directly transferred without the need for intermediaries between people and even machines. The act of Tokenisation is merely a simulation of securitisation – allowing for individuals or collectives to digitise the value of their assets. This is made possible using public blockchains such as Ethereum and their globally recognised token standards. Ethereum is an ideal choice for a distributed smart contract ledger because of its highly adopted and well documented standards for both fungible (ERC 20) tokens and non-fungible (ERC 721) tokens. Fungible tokens are often used to represent value or credit – where each unit is worth the same. This can also be applied to time, or voting rights. Non-fungible tokens are required for anything where each unit has a different value, such as stock certificates, land titles or digital representations of other physical assets. Blockchain technology introduces new definitions to the term immutability, providing a shared open platform controlled by no single person or entity, which in-turn facilitates a trustless environment with inescapable tamper proof audit trails.

So what’s missing? Why is everyone saying that blockchains can help Islamic finance when I find myself thinking that its Islamic finance that can really help blockchains? Does anyone else see the potential for such synergy here in Malaysia? Not only has this been a critical topic of prolonged discussion within the Blockchain Embassy, but we also have HelloGold who are tokenising the ownership of gold using ERC20 tokens. We also have ATA Plus, one of six licensed equity crowdfunding platforms utilising the blockchains to secure their data. Crowdfunding is a great example of the application of democratising financing through contribution from the masses. Crowdfunding has evolved from basic donation and reward, to now include equity and debt – presenting a much needed alternative to centralised financial service providers such as bank loans and VC funding.

What about the central banks? Do we even need central banks? What kind of currency would we be using if we didn’t have central banks to manage things? Can monetary policy still be practiced? It’s critical for us to first understand how fundamental services within the traditional finance markets keep things moving. The inefficiencies of the current financial landscape cannot be easily escaped – momentum is an illusion that is often turned-off at midnight whilst consolidation takes place. It’s certainly not designed for financial innovation, or inclusion – let alone entrepreneurial growth.

With this in mind, can the Islamic Gift Economy be used as a way to replace the role of central banks and financial intermediaries whilst providing fair monetary policy to society? In the IGE, there are specific kinds of institutions who are able to collect funds and redistribute them with the sole purpose of circulating wealth within the economy. There is also Zakat (which is a cause-based religious tax), Waqf is another such type of institution. Waqf is an Islamic concept that can be simply defined as a cause-based endowment of assets – provided on terms that the asset must be used for the benefit of society as a whole.

There are different kinds of Waqf institutions, Cash Waqf institutions are institutions that collect fiat currency as Waqf and then channel the funds into various projects that are a benefit to society. The cash-based Waqfs act as platforms that connect contributors and donors to the end beneficiaries or the disenfranchised members of society who need the most help. Waqfs characteristics are that they must be perpetual, are irrevocable, and inalienable. This means that assets declared as Waqf should remain as Waqf forever, and can never be returned, cannot be sold, inherited or deposited. This opens up the possibility for decentralised banking, which democratises the role of central banks by applying cause-based monetary policy through these cash Waqf institutions. In doing so, we are immediately circulating wealth within the economy with social grassroot initiatives.

We can see some active examples of the islamic gift economy at work through collectives such as the Grameen Bank who would initially only ever give out loans to individuals who were part of a small unofficial group with a minimum of four members. This brings in a social risk self-management dynamic where the participants will be able to support each other to repay their loans. It was through these collectives that micro-insurance services were provided along with more support for growth between all of the participating entrepreneurs. Evolving from this concept, collectives can actually serve multiple purposes. They can not only act as a touchpoint for various services to and between individual members that share interests and assets – but can also enable social engagement whilst facilitating local exchange and circulating funds.

The rise of the P2P gig economy is encouraging peers to engage without the need for intermediary assistance beyond financial liquidity. One of the main reasons that these financial intermediaries exist is because of the legacy infrastructure that we rely on today to make transactions happen. When we cross borders, these inefficiencies are infinitely amplified. This needs to change, and we can already see the start of this exciting evolution ahead of us.

If this is an area of interest to your organization, please reach out and look to join our growing blockchain consortium so that you can be a part of the discourse.

Written by Hammam Radwan – @HammamRJ







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