What are the blockchain opportunities and challenges for Islamic finance?

Blockchain technology is being applied in a variety of contexts in the conventional financial services industry, by banks, payment providers and private individuals alike. How can Islamic financial institutions take advantage of its potential?

WHAT IS BLOCKCHAIN?

Web-based blockchain is a technology that tracks and records data across a digital ledger network made up of participating parties that will independently verify and store each instance of transaction or contract as it originates and changes.

The distributed ledger system means that instead of data being kept only by two counterparties or in a central repository, they are verified and stored across hundreds or thousands of computers across the globe.

The data, representing transactions or contracts, are accessible by all participants that check and record them with timestamps, while adhering to privacy data.  

A Deloitte report (pdf) notes that blockchain start-ups are using the technology to provide a variety of solutions for the financial industry. Some of these include: giving customers access to cryptocurrencies, tracking and settling digital and mainstream financial assets in an environment that is cryptographically secure, reducing the complexity and number of intermediaries participating in existing transaction processes, and better managing digital risks, such as settlement and counterparty risks.

Companies, start-ups and consortiums are using the blockchain technology to develop their own solutions and platforms that products—commercial or open source—can sit on.

HOW IS BLOCKCHAIN USED BY THE FINANCE INDUSTRY?

In a report released in September based on findings from a survey of 200 banks, IBM said that banks and other financial institutions are adopting blockchain technology “dramatically faster” than initially expected, with 15 percent of top global banks intending to roll out full-scale, commercial blockchain products next year, and 65 percent of banks expected to have blockchain projects in three years’ time.

Transactions already in play and announced projects involving global names include:

Last month the first cross-border transaction between banks using multiple blockchain applications took place between Commonwealth Bank of Australia and Wells Fargo, involving 88 bales of cotton bought by Australian company Brighann Cotton Marketing.

New York-based financial technology company R3 has developed a consortium of more than 70 of the world’s biggest financial institutions—including banks (CBA and Wells Fargo are members of the consortium but R3 did not play a part in the first transaction as explained in the previous para), insurers, and fund managers—to work on what it hopes will be an industry standard for the global financial markets. In late October, R3 announced it would contribute its code to the cross-industry Hyperledger project, which is led by the non-profit Linux Foundation to advance blockchain technology by coming up with common standards.

Bank of America Merrill Lynch is working with Microsoft to use blockchain technology for trade finance, running on the latter’s Azure cloud.

Visa has announced it will launch a blockchain payments service next year.

The Securities and Exchange Commission (SEC) in the U.S. has allowed online retailer Overstock.com to issue company stock using blockchain technology.

MAJOR AREAS OF BLOCKCHAIN-RELATED OPPORTUNITIES FOR ISLAMIC FINANCE

The Islamic finance industry lags behind its conventional counterpart in leveraging blockchain. However, Islamic financial institutions are exploring several interesting opportunities.

The first movers to apply blockchain technology to Islamic finance are entrepreneurs, including those who have established start-ups such as Blossom Finance and EthisCrowd, and OneCoin Ltd, a cryptocurrency company that is the first to launch a certified Shariah-compliant product. Other first movers include Finocracy, a Dubai-based fintech start-up.

There are several major opportunities in the mainstream Islamic finance space.

Ville Oehman, Founder and CEO of Quantified Assets, a Singapore-based private investment company involved in the bitcoin market, cites trade finance as one of the core focus areas for blockchain technology in Islamic finance. “There is also a tremendous opportunity in the cryptocurrency and payment applications, as the technology allows redefinition of what is money and how it can be used,” added Oehman.  

Zareen Roohi Ahmed, Founder of IFCC, a UK-based think tank on Islamic finance and cryptocurrency, highlights two opportunities for Islamic finance to make good use of blockchain technology: resolving uncertainty (gharar) in transactions, and providing banking services to unbanked Muslims. On the second point, Ahmed explained, “When combined with mobile phone technology, the capacity for low cost remittances and microfinance loans using blockchain technology can transform the payment ecosystems within developing regions.”

At the same time, it is important to maintain perspective on these opportunities. Tim Lea, ‎CEO of blockchain start-up Veredictum.io, said, “We are at the very inception of any opportunities that are blockchain-related for Islamic finance. Until we see vastly improved basic infrastructure, which the blockchain can provide within developing nations, we are way off being able to see pure blockchain-related Islamic finance plays.”

CHALLENGES FOR OIC COUNTRIES

In Oehman’s view, there are no particular challenges to applying blockchain technology in Organisation of Islamic Cooperation (OIC) countries, provided that those working on these projects have a good understanding of the relevant compliance requirements and culture.

However, Ahmed cites three particular challenges: a lack of Shariah-compliant source currencies, reluctance by OIC governments and central banks to research new technology in this area, and a strong, critical need to further develop Shariah expertise in this field. On tackling the third challenge, Ahmed says, “OIC governments need to invest urgently in training, research and development of all stakeholders across all segments of society, particularly in relation to how Islamic microfinance can be advanced using this technology.”

For Veredictum.io’s Lea, two areas present challenges in OIC countries harnessing blockchain technology: a lack of core infrastructure, and the niche nature of the Islamic finance market.

The lack of core infrastructure includes the lack of credit scores in many countries of the OIC, as well as issues relating to establishment of identity and confirmation of asset ownership, particularly relating to land.

In addition, relating to the niche nature of Islamic finance, Lea says, “Developers and other expertise in the blockchain space will tend to be drawn to where the larger opportunities are. There won’t be enough of a drawcard to attract experienced teams, and as a result it will hold back the development of new Islamic finance opportunities surrounding the blockchain.”

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