Blockchain has captivated developers and innovators worldwide, and tech pioneers outside the G-7 are looking to leverage blockchain in the legal and financial spheres to their competitive advantage. That is especially true in the Middle East, where blockchain concepts and pilots are quickly being adopted in Islamic finance.
Blockchain, the most famous of distributed ledger technologies, is a peer-to-peer, shared digital database of transactions encrypted and confirmed by computers on the blockchain network. Transactions are encrypted and recorded in “blocks,” and each block is added to the ledger, or “chain.”
Transactions are recorded after authenticity is verified by a majority of computers on the network (called “nodes”), rather than going through a single centralized verifying authority like a central bank or payment processor. This technology arose from the 2008 financial crisis that saw major centralized points in the finance chain fail, and it was designed to be a safer, more reliable replacement.
Nodes can number in the thousands, making it virtually impossible to record fraudulent transactions. Thus, blockchains are often considered a safe and immutable databases, with algorithms ensuring each node has the most current database version. Blockchain is famously the tech underlying Bitcoin and other cryptocurrencies, which are inherent to blockchain use, but is being piloted in almost every market sector.
Islamic banking and finance are unique in that they must comply with Islamic law and religious teachings. Differences from US and UK finance practices include prohibiting the following: paying and charging interest (riba, considered exploitative under Islamic law); investing in excessively risky and uncertain enterprises (gharar); speculation or gambling investments, and investments in alcohol, pork, or other prohibited (haram) activities. Islamic finance proponents note neither party is exploited in a transaction or benefits disproportionately more than the other.
Islamic finance allows several types of financing arrangements and investment vehicles, including equities ownerships and tradeable fixed income instruments called sukuks, which are asset ownership shares, not debt obligations, favored by institutional investors. Blockchain solutions have increasingly targeted retail sukuk issuances.
Islamic banking and finance are unique in that they must comply with Islamic law and religious teachings.
According to the World Bank, Islamic finance has emerged for funding development worldwide, including in non-Muslim countries. Islamic finance has expanded rapidly since the 1990s, growing at 10% to 12% annually, and Islamic fintech has boomed in the last five years. Islamic finance assets are valued at more than $2 trillion, including bank and non-bank financial institutions, capital markets, money markets, and insurance (takaful). Many top law firms in the United States, Canada, Australia, and Europe now have Islamic finance practices.
Benefits of blockchain
Global ratings agencies identify blockchain as a growth tool for Islamic finance. Standard & Poors expects post-pandemic growth for 2021 for Islamic finance, in part due to standardizations and automation technologies like blockchain; and according to Moody’s, blockchain will be a major catalyst for sukuk market growth, allowing issuers of conventional bonds to more easily tap liquidity available in the Islamic finance space. The industry may also adopt blockchain cloud storage for convenient yet secure access to essential information regarding Islamic finance, as well as low-cost mobile accessibility by Islamic communities in poorer countries without basic infrastructure.
S&P reports a new platform for sukuk issuance and data management leveraging blockchain has been launched for Gulf Corporation Council (GCC) members. Managing sukuk transactions with blockchain is designed to improve transparency and asset traceability, and standardize legal documents in compliance with Sharia law. This transparency addresses significant aspects of issuing sukuks, such as criticisms of opaque issuance and returns processes, and the difficulties tracking underlying assets or cash flows.
If blockchain standardizes and simplifies complex parts of issuance, GCC blockchain adoption could see volume increase and sukuk markets expand to new classes of issuers and investors previously excluded because of costs or complexity.
The first blockchain sukuk issuance occurred in October 2019 through Indonesian microfinance cooperative BMT Bina Ummah, raising 710 million rupiah (US $50,000) through Blossom Finance’s SmartSukuk platform. The sukuk was structured under Shariah profit-sharing principles called mudaraba with proceeds used to expand entrepreneur financing. Dubai’s Wethaq followed with an R3 Corda blockchain sukuk issuance in November 2019.
The United Arab Emirates has been blockchain-forward for years, and in 2018 its Al Hilal Bank became the first Islamic bank to execute a secondary sukuk transaction via the Ethereum blockchain. Its Securities and Commodities Authority has drafted regulatory frameworks for blockchain and crypto-transactions to protect consumers from fraud and ensure security and data protection. In 2020, the Abu Dhabi Islamic Bank became the first Islamic bank to successfully execute trade finance distribution transactions using blockchain technology.
Bahrain rivals the UAE in blockchain adoption. The altcoin Lumens (XLM) — the sixth largest cryptocurrency in the world with a market cap of more than $4 billion — was found Sharia-compliant by the Shariyah Review Board and licensed by the Central Bank of Bahrain. Bahrain’s electronic network for Financial Transactions (BENEFIT) offers financial institutions Know Your Customer (KYC) utility via blockchain.
By contrast, blockchain has been mostly used for peer to-peer money remittances in Kuwait and Qatar. “Right now, blockchain technology has not been significantly utilized by institutions in Kuwait, however, it could be of great use when it comes to improving the security in remittances when locals or expats are transferring funds overseas,” notes Moayad AlSuwaidan, an associate at Meysan Partners in Kuwait. The Central Bank of Kuwait currently prohibits cryptocurrency trading, but the National Bank of Kuwait did launch a 2018 remittance service using Ripple’s RippleNet blockchain platform. Qatar has also banned crypto-trading, but Qatar’s Commercial Bank has joined R3’s Corda to develop blockchain applications.
IAl Rajhi Bank in Saudi Arabia, the Middle East’s spiritual hub and largest economy, used Ripple blockchain technology to automate contractual processes and auto-enforce contract terms, alleviating administrative and legal complexities and redundancies. Divisions of Saudi Arabia’s Islamic Development Bank have partnered with fintechs like Tunisia’s iFinTech Solutions to develop smart contracts and blockchain solutions addressing liquidity management issues and Islamic law compliance. The bank also partnered with Samsung-backed firm Blocko to build a blockchain-based credit enhancement system to minimize risk with credit financing to businesses and consumers.
Iran also increased its blockchain scope. The Central Bank of Iran, in partnership with Areatak, began developing the Borna platform, a national blockchain project using IBM’s Hyperledger Fabric as a central platform for smart contracts. The Iranian President recently called for a national cryptocurrency mining strategy, reportedly to work around U.S.-imposed economic sanctions.
Blockchain adoption in Islamic finance is admittedly still in infancy. GCC implementing a blockchain platform for sukuks would advance adoption rapidly. Until then, existing adopters and nations newer to blockchain are pursuing relevant applications and public-private partnerships, like Lebanon’s Blockchain Developer Bootcamp, Qatar’s FinTech strategy to innovate financial services with big data, AI, and blockchain tools, and Pakistan’s Institute of Business Administration partnering with Cybuke and Karachi’s Usmani & Co exploring blockchain implementation nationwide.
Even in blockchain-averse nations like Egypt, the most populous Arab nation, its banks are exploring blockchain remittances and cryptocurrency regulations. Indeed, Egyptian blockchain startups are increasing, and Nile University and the Academy of Scientific Research and Technology launched Egypt’s first incubator for cognitive technologies and blockchain. Egypt’s three-year agreement with the IMF to improve its ability to engage in global commerce has its blockchain advocates optimistic.
Islamic finance is unquestionably mainstream within the global economy. As blockchain further impacts how parties transact with Islamic entities, the upside is high for all involved in this sector.