Blockchain for Islamic Finance – Here’s why it matters

In the previous article, we talked about Stellar, one of the prominent start-ups focused on cross-border transactions.

The 4-year-old California-based start-up was co-founded by Jed McCaleb, who was also the co-founder of Ripple and the founder of Mt. Gox. Stellar has been working in partnerships with large corporates such as IBM, Deloitte and ICICI Bank, along with a number of fintech start-ups worldwide.

On July 2018, the company obtained a Sharia compliance certificate for its blockchain and associated cryptocurrency (Lumens). This should enable Stellar to partner with start-ups as well as established Islamic financial institutions, looking to build Sharia-friendly payment and remittance applications on top of Stellar’s blockchain.

What does it mean to be Sharia compliant for a blockchain or a cryptocurrency? How would a blockchain, cryptocurrency or token obtain Shariah compliance? And is it a real value add to their business?

Sharia Compliance

Financial products and contracts that are in accordance with the provisions of Islamic laws, are usually referred to as Sharia compliant. Islamic laws prohibit the payment or acceptance of interest, or Riba. Islamic laws also consider certain business activities to be Haraam, or prohibited and contrary to Islamic principles. These activities include dealing with alcohol, pork, gambling, pornography, paying and collecting interest (such as conventional banks) etc. Gharar (uncertainty or ambiguity) and Maisir (gambling or speculation) are also prohibited, which excludes most of the derivative investment products offered by conventional banks.

Islamic Financial Products

Restrictions imposed by Sharia does not necessarily preclude access of basic banking and investment services to customers that are seeking to adhere to Islamic laws. Islamic banks offer Sharia-compliant services to their customers. There are also a number of Islamic financial products available, where the contracts are structured to comply with Islamic laws. These include Sukuks (Islamic bonds), where investors get nominal ownership of assets and receive payments from profits or rents generated from the assets, instead of interest payments. In Takaful (Islamic insurance) products, the insured contribute towards to a common investment pool and bear the risks with the insurers, rather than paying premiums and the insurers assuming all the risk. There are also restrictions to the activities of the sukuk issuers and takaful insurers, to ensure that they do not engage or invest in activities that are Haraam.

How a Blockchain and Cryptocurrency achieves Sharia Compliance

Islamic banks (Saudi Arabia’s Al Rajhi Bank is the largest one globally) typically have Shariah advisory boards, comprising of Islamic scholars, which conduct reviews of their products and services. Companies can also engage accredited Sharia advisors to review and certify that the underlying structure and agreements do not violate provisions of Sharia.

In July 2018, Stellar announced that they obtained a Sharia compliance certificate from Shariyah Review Bureau, which is a Sharia advisor licensed by Bahrain’s central bank. The advisor also lists other fintech companies, such as Beehive P2P (Dubai-based crowd-lending platform) and Ovamba (Cameroon-based SME lender) among its clients. Review of the Sharia certificate document on Stellar’s website reveals some interesting details about the process. Let’s look at the findings below.

Blockchain – The certificate acknowledges that Stellar’s blockchain is simply a network of decentralized servers that power its distributed ledger technology. Therefore, the network itself does not violate Sharia laws, as it is just a tool for making payments and recording transactions. This would hold true for most blockchains that choose to get themselves reviewed for Sharia.

However, the institutions utilizing such blockchains would still need to get their own activities reviewed.

Cryptocurrency – The certificate lays down a few conditions for a cryptocurrency to be compliant, and Lumen (or XLM, Stellar’s cryptocurrency) seems to meet the criteria. It includes standard conditions such as the parties having clear possession of the values being transferred, amount being sent should be same as amount being received. Also, transfers should not be conditional, entail any evil or un-Islamic intentions of entities, or be carried out in forward or futures markets.

Once again, there would be a number of cryptocurrencies which would fit the bill. Indeed, Bitcoin could be deemed Sharia-compliant, if Satoshi Nakamoto were to approach a Sharia advisory board to review its structure. But entities dealing with such cryptocurrencies may or may not be compliant themselves, depending on their own business and intentions.

Benefits of Sharia Compliance

Many of the guidelines provided by Sharia are similar to the ESG (Environmental, Social, Governance) criteria. Both Islamic and ESG investments have witnessed rising demand in the last few years from socially conscious investors.

Moreover, the Middle East presents a huge market for start-ups like Stellar, as it contains some of the largest remittance corridors globally. Islamic financial institutions get regularly audited by Sharia advisory boards, and would prefer partnering with companies that are themselves Sharia-compliant.

Moving Forward – Sharia in Crypto-sphere

A rising number of companies in this eco-system are looking to tap into this huge market potential. Start-ups such as UAE-based OneGram and Malaysia-based HelloGold have announced Sharia-compliant tokens, backed by physical gold.

Halalchain, established in Dubai in October 2017, launched the first blockchain catering to the Halal (permissible by Sharia rules) food, cosmetics and medicines. The company raised funds through an ICO (initial coin offering) in December 2017. A similar enterprise tracking Halal food supply chains, Halal Trail, was established in the UK in 2017.

In August 2018, another UAE-based start-up ADAB Solutions company announced that it is launching the First Islamic Crypto Exchange (FICE), which could be the first Sharia-compliant cryptocurrency exchange.

Islamic banking and finance are growing fast – Muslims constitute roughly a quarter of the world’s population, but Islamic banking is still about 1% of the global banking industry. As an interesting PR ploy, OneGram launched its ICO on the first day of Ramadan in May 2017, and launched its blockchain with the first transaction on the day of Eid in June 2018. Its unclear if such strategies will boost blockchain’s popularity among the world’s 1.8 billion Muslims, but Sharia boards worldwide will continue watching the crypto-sphere with great interest.