The Blockchain and Islamic Finance
By Hazik Mohamed
PhD in Islamic Finance
Managing Director, Stellar Consulting Group (Singapore)
The main efforts in Islamic Finance so far has been to
create new forms (Shari'ah-compliant standards) to
operationalise Islamic values and ethics into the current
conventional economic system and banking products.
While this is crucial to sustain the world as it is today, we
also need to develop new strategies to cope with the
next economy, which starts with a clear and deliverable
vision of a new world economy. And the new vision of a
new world economy will be driven by those who
embrace innovation that will build the future.
Here we look at the main building block to enable trust in
impersonal financial transactions in a highly globalized
society. This innovation called the blockchain will play a
crucial role in boosting the financial sector (banking,
insurance, investment, etc.) including the Islamic Finance
sector. Addressing the digital revolution that is
happening right now will foster competitive advantage
for the Islamic Finance industry.
It is clear that the digital revolution in financial services is
under way, and digital disruption has the potential to
shrink the role and relevance of today's banks, while
simultaneously creating better, faster, cheaper services
that will be an essential part of everyday life in the new
economy.
Fintech Revolution
Over the last decade, disruptive innovation in financial
services has emerged from financial technology (fintech)
start-ups. These new firms have been quicker than banks
to take advantage of advances in digital technology,
developing banking products that are more user-friendly,
cost less to deliver and are optimised for digital channels.
This relative success is unsurprising. These new players
are less burdened by the demands of regulatory
compliance which banks are subject to. They are
unencumbered by complex and costly-to-maintain legacy
systems. They can focus on creating single purpose
solutions, designed to offer an improved experience
within just one product or service.
They are more in tune with the peer-to-peer (P2P)
culture engendered by the explosion of social media. And
they are smaller organisations, designed for the purpose
of innovation.
Islamic Finance Today - November | December 2016
Also, much capital has flowed into the fintech sector:
US$23.5 billion of venture capital investment in 2013/14,
according to an analysis by Oliver Wyman.
Of this investment, 27% has been in consumer lending,
23% in payments and 16% in business lending. Fintech has
two unique selling points: better use of data and
frictionless customer experience. But to date these have
been limited to relatively simple propositions such as e-
wallets and P2P lending.
The conventional finance sector is already scrambling to
cope with these digital disruptions in order to stay afloat
and finding ways to embrace such disruptions in their
respective sectors to stay relevant and retain market
share.
Certain segments within Islamic finance has been too
caught up in Shari'ah-compliance debate instead of
recognizing that we are at the cusps of an economic
evolution. The industry should also recognize that these
technological advancements are essentially aligned to the
principles of the Shari'ah that requires and upholds the
values of trust, honesty and transparency.
In this article, we attempt to highlight the potency of the
blockchain (the backbone to the cryptocurrency
technology), and subsequently its potential applications
as the technical experts unleash its capability and evolve
its strength, very much like what happened for the
internet in the late 1990s and 2000s.
“This innovation called
the blockchain will play
a crucial role in boosting
the financial sector (banking,
insurance, investment, etc.)
including the Islamic
Finance sector.”
IFT pgs 27-30
What is the Blockchain?
Blockchain is a peer-to-peer public ledger maintained by a
distributed network of computers that requires no central
authority or third party intermediaries. It consists of three
key components: a transaction, a transaction record and a
system that verifies and stores the transaction. The blocks
are generated through open-source software and record
the information about when and in what sequence the
transaction took place.
This “block” chronologically stores information of all the
transactions that have taken place in the chain, and
therefore the name — blockchain. In other words,
blockchain is a database of immutable time-stamped
information of every transaction that is replicated on
servers across the globe.
This technology is the foundation of cryptocurrencies such
as the bitcoin. In fact, blockchain technology was first
introduced in 2009 with Bitcoin, a crypto-currency based
distributed payment protocol.
Blockchain's main innovation is a public transaction record
of integrity without central authority. Blockchains are
decentralised by nature that is shared by all nodes
connected to a set network.
How the blockchain works for cryptocurrencies
Source : http://blockgeeks.com/guides/what-is-blockchain-technology-a-step-by-step-guide-than-anyone-can-understand/
Islamic Finance Today - November | December 2016
Blockchain technology offers everyone the opportunity to
participate in secure contracts over time, with a secure
record of what was agreed at that time. This innovation
carries a significance stretching far beyond
cryptocurrency.
The blockchain lets people who have no particular
confidence in each other collaborate without having to go
through a neutral central authority. Simply put, it is a
mechanism for creating trust. Within this open ledger
system, the blockchain offers an inherent level of trust for
the user, eliminating the need for the middleman and
mitigating the risk of human error.
Its publicly accessible log of transactions ensures that the
data is protected against tampering and revision, and it is
virtually impossible for individuals to modify or replace
parts of the blockchain secretly.
A full copy of the blockchain contains every transaction
ever executed, making information on the value
belonging to every active address (account) accessible at
any point in history. Every block contains a long reference
number or hash of the previous block, thus creating a
chain of blocks from the genesis block to the current
block. Figure 1 illustrates how a transaction is recorded on
the blockchain, based on the cryptocurrency protocol.
IFT pgs 27-30
Validation is required for a new block to be added on to the
blockchain. This validation process, also called mining,
allows pending transactions to be confirmed; enforces a
chronological order on the blockchain; protects the
neutrality of the blockchain; and enables different
computers (or nodes) to agree on the state of the system at
any given time.
In traditional transactions such as money transfers or
foreign currency, there is usually an intermediary or a
centralized entity that records the transmission of money or
currency that exist apart from it. In blockchain, the token or
digital coin itself is what has value, which is determined by
the market. This is what makes the system a truly
decentralized exchange.
When people buy or sell bitcoins, a secret key or token is
broadcast to the system. “Miners” use nodes, computers or
devices linked to a network, to identify and validate the
transaction using copies of all or some information of the
blockchain which is accessible publicly. Before the
transaction is accepted by the network, miners have to
show 'proof of work' using a cryptographic hash function (a
special algorithm) that aims to provide high levels of
protection.
[Proof-of-Work (PoW) is a function that is hard to compute,
but easy to verify, which serves as a probabilistic
cryptographic proof of the quantity of computational
resources controlled by a given node. Every block requires a
PoW with a pre-specified difficulty level in order to be valid,
and in the event of multiple competing blockchains the
chain with the largest total quantity of PoW is considered to
be valid].
As progress is made in the blockchain technology, its use
will become more efficient and applicable in many ways, i.e.
to transact anything of value, not just digitizing currency.
Evolution of the Blockchain
Not only is there the possibility that blockchain technology
could reinvent every category of monetary markets,
payments, and financial services but it might also offer
similar reconfiguration possibilities to all industries within
the economy, e.g. as registries for luxury goods (diamonds
or works of art) and smart contracts for loans, wills and
trusts, or intangible assets like patents, trademarks and
copyrights. The blockchain is fundamentally a new
paradigm for organizing activity with greater efficiency, and
greater scale than current models.
We believe that the blockchain technology leverages on
decentralization well and offers a truly global scope and
scale that was previously impossible.
Islamic Finance Today - November | December 2016
Limitations of the Blockchain
The blockchain industry is still in the early stages of
development, and there are many kinds of limitations.
Ideally, the blockchain industry would develop similarly to
the cloud-computing model, for which standard
infrastructure components - like cloud servers and
transport systems - were defined and implemented very
quickly at the beginning to allow the industry to focus on
the higher level of developing value-added services instead
of the core infrastructure.
The current limitations are both internal and external, and
include those related to technical issues with the
underlying technology, public perception and government
regulation.
Conclusion
The promise of the blockchain creates the possibility of
coordinating our transactional activities within a strong
mechanism of trust and transparency. This public ledger
system of transparency and then making it available to
anyone like the internet seems to be able to solve the
coordination for the transactions that occurs within the
now global economy.
Thus blockchain is the technology that will operationalize
the mechanism of trust as we progress from personal
exchange to impersonal exchange due to globalization. We
suspect that this technological backbone will be
commonplace in 6 to 8 years' time, through the advent of
crypto-currencies, smart contracts, full-reserve lending
platforms, multicurrency money transfers, etc.
Fintech using the blockchain technology will incorporate
Islamic values (of trust, justice, equality and efficiency) into
finance that embodies and promotes the spirit of the Sharia.
In addition, the adoption of the blockchain technology will
allow Islamic Finance to adapt to the changing landscape of
modern economic transactions instead of playing catch-up
by replicating soon-to-be outdated conventional practices.
ANALYSIS
“Fintech using blockchain
technology will incorporate
Islamic values (of trust, justice,
equality and efficiency) into
finance that embodies and
promotes the spirit of the
Shari'ah.”
IFT pgs 27-30