As banks and financial institutions in the Islamic world are opening up to the adoption of blockchain technology, many are wondering if it holds any potential for Islamic finance. Others have pondered if the use of blockchain-backed cryptocurrencies goes against sharia or Islamic law. Before dissecting these claims, it is crucial to understand the meaning of Islamic finance.
Understanding Islamic Finance
As described by Faleel Jamaldeen, Islamic finance is just like any other conventional financial system featuring banks, investment firms, insurance companies etc. but with the sole difference of operating according to sharia. However, the above financial institutions are governed both by Islamic law and the finance industry rules and regulations that apply to their conventional counterparts.
Importantly, one of the major differences between conventional and Islamic finance or banking is the forbidding of riba or usury (interest). This condition makes it difficult to work with Western financial firms, leaving them with less options, futures and most derivatives.
How will blockchain harmonise with Islamic finance?
Taking the key principles of Islamic finance into consideration, it is understandable how blockchain could provide a solution for the Muslim world. Blockchain technology is all about the elimination of middlemen and, as a result, the reduction of transactions costs in the process.
Smart contracts can play a major role in utilising blockchain for Islamic finance or banking as it has the power to automate the entire process for Islamic institutions, including enforcing the terms of the contract. The capabilities of smart contracts will eliminate redundancy associated with sharia-compliant financial products and reduce administrative and legal complexities.
The distributed ledger technology (DLT) provides the framework to reduce fraud, corruption and cost-extensive processes. By providing transparency and reducing barriers, blockchain discourages investors.
This relationship between blockchain technology and Islamic finance goes both ways. In exchange, Islamic finance could also be beneficial to the blockchain industry because it provides more legitimacy. Despite Islamic banks’ strict standards of complying with sharia, blockchain technology and organisations have been working with more and more Islamic banks worldwide. By demonstrating their ability to comply with Sharia-based regulations, blockchain is earning legitimacy that others in the finance world refuse to give.
Blockchain tracks any asset with value through distributed ledger technology (DLT), thus giving it credibility because no single authority controls it. Utilising blockchain in Islamic finance allows the tracking of the real assets that Islamic finance is based on, ensuring documentations is not manipulated. Educating key people such as Sharia scholars on these technologies will only help in getting clearer fatwas or Islamic legal opinions given by a scholar.