The revolution against the banking industry is taking place at a breathtaking speed with the movement spearheaded by a new breed of technology entrepreneurs. The finance industry has long been marked by complex regulations, high barriers to entry and economies of scale and this is all set for disruption by the present fintech revolution. One of the most controversial and debated topics in the finance industry is blockchain.
Blockchain is a technological evolution that can support and enhance the transparency feature, which is the core underlying principle of all transactions in the Islamic finance industry. It is a distributed ledger that records that a transaction has happened, when it happened and that it has happened correctly without revealing any confidential details about the subject or the involved parties. To summarise the evolution like it is happening, the next in line is the bitcoin. It is an encrypted virtual currency using the blockchain protocol to perform financial transactions. This was the initial use of blockchain but as of now it exists as a software protocol on its own with applications ranging from virtual wallets, payments, clearing and settlement solutions amongst many others.
“ TERM ‘SMART CONTRACT’ WAS COINED BY A CRYPTOGRA- PHER, NICK SZABO, WHO IS WIDELY KNOWN FOR LAYING THE FRAMEWORK OF THE BITCOIN.”
DEMYSTIFYING SMART CONTRACT TECHNOLOGY
Smart contracts is another technology similar to bitcoin. The main feature of smart contract technology is that it can reduce costs for financial transactions by circumventing regulatory infrastructures while simultaneously reducing risk through non-discriminatory execution. Greater efficiency is predicted in servicing markets on account of a lack of a central counter-party agent.
The term ‘smart contract’ was coined by a cryptographer, Nick Szabo, who is widely known for laying the framework of bitcoin. The inception took place in 1994 with the advent of the World Wide Web itself. Smart contracts are basically just computer programs consisting of if-then statements indicating that ‘if’ a certain condition is fulfilled then do this ‘else’ do something else listed in the program code. So if a certain programmed condition is triggered then the contractual clause following that condition is executed by the smart contract.
These automated programs interact with real-world assets differentiating them from normal computer programs.
Currently smart contract technology is being built on top of bitcoin and other virtual currencies. Bitcoin is also a computer program and so smart contracts can interact with it and trigger release and transfer of payments. The distinguishing feature in comparison to paper-based agreements is that smart contracts are computer programs with the capability of unilaterally applying strict rules and consequences on the basis of fresh data inputs. Further the blockchain assures that everyone is seeing the same thing without the reliance on having to trust each other.
The applications of this technology are immense but restricting it to the financial world, it can be conveniently said that any kind of business logic relying on data can be coded by way of smart contracts.
ISLAMIC FINANCE CAPITAL MARKETS
Securities that are based on payments and rights, which are executed according to predefined rules can be coded as a smart contract in capital markets. Experiments are ongoing on the issuance of smart bonds. Sukuk issuance follows a strict Shari’a law and principles of permissible variance, cleansing, the balance-sheet ratios to be satisfied, the ‘conglomerate’ issue and the ‘core’ activities. These can also be coded as if-then statements to ensure both compliance to the Shari’a and transparency for all involved. This would increase the mass appeal of the product amongst Muslims as there can be no discrepancy involved when using a blockchain implementation via a smart contract.
ESCROW ACCOUNTS
Smart contracts can easily be set up as escrow ac- counts monitoring the exchange between two parties. Real estate projects or selling the shares of a company can use smart contract-driven escrow account to facilitate the conditional transaction. An instance would be that the buyer would transfer funds to the contract account and after the ownership has been fully transferred, the contract would automatically release the funds to the seller.
INHERITANCE LAW
Inheritance as ordained by Islam can be coded by means of various conditions expressed in religious doctrines in a smart contract, specifying conditions when a dead person has left a descendant or not and likewise. The triggering condition that sets the contract into execution would be the death of a person. This would increase fairness in distribution of wealth according to the Shari’a, resolve any potential disputes that could arise by means of transparency and reduce the time and effort needed for the process of determination of the wealth allocation to different parties followed by the transfer of money to the respected family members.
LOANS
Lending money is a core activity of any financial institution. Automating the lending process would result in immense cost reductions. Loans can be set up as smart contracts on a blockchain together with the collateral ownership information. In case the borrower misses a payment or a few designated payments – the number agreed upon by the lending institution- then the smart contract can revoke the digital keys that allow access to the collateral.
The coming times could very well do away with banks. Consider the case of mortgages. A person gets his mortgage through a bank, which won’t generally be held by the bank for the tenure of the loan but would be sold to an investor. The borrower however keeps making payments to the bank and not the investor. The bank processes the monthly payments with fractions being sent to the investor, for taxes and home insurance. For this simple operational task the bank takes up to a quarter to a half percent per year to service the mortgage. Smart contracts can do this operational task and either minimise the fees that banks charge or make the investor or lenders come in direct contact with the person through a pool of willing investors and lenders. This pool on a blockchain would aid in transparent transactions fuelled by smart contracts to facilitate them. Till this is not possible banks can adopt smart contracts to eliminate the mortgage processing fees resulting in lowered cost of home ownership.
Auto finance contracts are such that one contract type satisfies all. They are documents that anticipate as many outcomes as possible based on human behaviour and typical legalities involved. Thus they are particularly suited to be coded into smart contracts.
CRYPTOCURRENCY WALLET CONTROLS
Dealing in cryptocurrency is an issue to be discussed by Shari’a scholars but consider the following Hadith by the Prophet (May peace and blessings be upon him) in ‘The book of Transactions (Kitab Al- Buyu’)’ of Sahih Muslim:
‘Ubida b. al-Simit (Allah be pleased with him) re- ported Allah’s Messenger (may peace and blessings be upon him) as saying: Gold is to be paid for by gold, silver by silver, wheat by wheat, barley by barley, dates by dates, and salt by salt, like for like and equal for equal, payment being made hand to hand. If these classes differ, then sell as you wish if payment is made hand to hand.’ (3853, Muslim).
This clearly shows that dealing in cryptocurrencies by the parties involved should be permissible by analogy as it comes in ‘like for like’. Wallets can be set up, controlled by smart contracts. These can include conditional clauses like daily withdrawal limits and restrictions like money that can be spent only on certain kinds of assets, in a certain geographical area or between two dates and likewise. The possibilities are endless and the savings would be huge considering the global reach of such a platform.
PROXY LAWYERS
When considering routine financial transactions, lawyers are involved in repetitively processing mundane tasks and yet consumers have to spend a large amount on their fees to have them go through their wills or contracts. Theoretically smart contracts can do a greater portion of what the lawyers do but practically speaking using them to support the legal system in the present age would reduce the costs associated with the process. The smart contracts could function as an intermediate layer between transacting and going to court. The future holds a different role for lawyers where they can be seen producing smart contract templates, which would be customisable as per the needs of a company.
TAKAFUL
Smart contracts will prove to be a boon for the Islamic Insurance industry. Since the smart contract is an automated computer program, the operating costs would reduce, speed of execution would increase and there would be greater efficiency in claims processing. The transparency and lack of textual ambiguity in cod- ed smart contracts would prevent legal disputes.
“INHERITANCE AS ORDAINED BY ISLAM CAN BE CODED BY MEANS OF VARIOUS CONDITIONS EXPRESSED IN RELIGIOUS DOCTRINES IN A SMART CONTRACT, SPECIFYING CONDITIONS WHEN A DEAD PERSON HAS LEFT A DESCENDANT OR NOT AND LIKEWISE.”
There would also be less insurance fraud on account of the contract being preprogrammed according to some specific conditions. Smart contracts are cut out for takaful as islamic insurance involves peer-to-peer insurance with policyholders supporting each other financially in times of crisis. Till now islamic insurance is being managed by a takaful operator. With the use of smart contracts, the operator can be replaced by a smart contract managing a pool of policyholders in a distributed blockchain comprising of ‘permissioned’ ledgers. These ‘permissioned’ ledgers use legal entities to validate transactions and are relatively compatible with existing regulations. This scheme complying with regulations would increase the reliance of consumers on the smart contract-driven insurance scheme.
TAILOR-MADE FOR ISLAMIC FINANCE
Islamic finance industry is all about earning money through a set of sound principles governed by the Shari’a. Smart contracts are computer programs that run according to some predefined conditions. The adoption of smart contracts by the Islamic finance industry is the most natural thing to do, not just to gain a strong foothold in this technological revolution, but also to be able to fully comply with the Shari’a in a transparent way. The Shari’a laws can form the conditions of a smart contract. Honesty, transparency and trustworthiness are qualities that should make a financial transaction in the IF industry, and smart contracts are inherently all of these. Blockchain provides a distributed trustworthy storage and smart contracts provide distributed trust-worthy calculations. Equality for all is a principle dear to Islam and smart contracts would pave the way for such an equality by making financial services available to the poverty-ridden sections of the society. Reductions in costs associated with the processing in banks and hiring lawyers would provide a larger section of the people to utilise their services. The Muslims, who could not trust financial institutions to be implementing the Shari’a law can rest at ease with smart contracts, knowing and seeing the conditions that go into making the automated contracts. Despite the fears normally associated with any new technology and the challenges and difficulties it would offer, smart contracts are a technology worth investing in for the potential it offers for the future.
