How Compatible Are Blockchain and Islamic Finance?
Only a few times in history, have we been faced with a situation where the new meets the old in a mutually beneficial union. Blockchain technology, a brand-new exciting technology known for its disruptive capabilities, is ready to strike once more. This time, it has set its sights on none other than Islamic finance, a historical and traditional financial system that raises capital in accordance with sharia (Islamic law). The sector is estimated to have over $2 trillion sharia-compliant assets in over 60 countries worldwide. Islamic banking is designed on two fundamental principles:
1. The use of interest is forbidden, which means their model is based on sharing of profit and loss concept.
2. The bank cannot create any debt without goods and services to back it.
Benefits of Blockchain for Islamic Finance
Since its early days, blockchain has been described as a digital ledger in which transactions are recorded chronologically and publicly. This is what appeals to the many things Islamic institutions considering the use of blockchain platforms. Islamic finance is deemed to be in the interests of the people as a whole, an objective that is aligned with that of blockchain technology. Not to mention, Islamic finance will go a long way in its applications and processes when smart contracts, digital tokens etc. are put to play.
One of the key principles of Islamic Banking is based on having enforceable contracts which are impartial, transparent and agreeable between the parties that engage in a banking transaction. Smart contracts, defined as self-executing digital contracts, have what it takes to automate the entire contractual process for Islamic banking and other financial institutions. This, coupled with the fact the smart contracts streamline the processes of Islamic financial institutions, reducing administrative and legal costs, is something that appeals to not only Islamic Banking but conventional banking as well.
Furthermore, a decentralised network eliminates the risk of conflict and moral hazards between participants. Blockchain technology can easily manage huge amounts of data from financial institutions, both Islamic and conventional Western institutions. A distributed network eliminates the need for the manual documentation of transactions, reducing risks of errors and fraud.
It is also important to note that fiat money is debt-based. That means when a bank makes a loan, it creates a matching deposit in the borrower’s account, thus creating new money. In Islam, money should process intrinsic value and is asset-backed. Cryptocurrencies and other digital assets can be seen to be more Islamically-inclined since it is backed by real value.
Blockchain can be used to improve business processes and streamline operations. It is undeniable that blockchain integrates Islamic values of justice, equality and trust into Islamic finance, which represents the spirit of sharia.
