Will Crowdfunding & Blockchain Technology Restyle Islamic Finance?

IsDB held its 44th annual meeting in Marrakech last month. I moderated a panel about blockchain technology and crowdfunding platforms in Islamic finance industry for ICD (Islamic Corporation for the Development of the private sector) alongside the summit. I was not that familiar with the financial potential of blockchain technology and I honestly was very excited to uncover what perspectives the technology offers and to be in the know of the latest disruptions in the industry I could possibly implement in eEducation.Africa, an e-learning platform I am currently launching.

I thought: wouldn’t it be amazing if I could launch an ICO to offer a halal coin learners could exchange against their halal products and services once they acquire the skills on eEducation.Africa? But then, a million doubts and questions popped out of my mind: Will crypto ever be a thing really? Isn’t it just an institutional tool for now? I only hear about blockchain Sukuk, waqf … Crypto did not go mainstream yet. So maybe it’s too early … Or is it too late considering that today, it became impossible to launch a successful coin with the right network effect?

The high level experts of the panel gave clear insights into what possibilities the Islamic finance ecosystem offer.

First, to make sure I don’t lose your attention if you are a newbie to the blockchain technology, let me clarify what it is. Before Blockchain technology, when exchanging documents on the internet, files would be duplicated and then sent to recipients. Blockchain is a technology that made it possible to identify the documents that are exchanged and make sure the sender loses and transfers the property of the sent documents. This has major potential of disruption in many industries, primarily finance. Cryptocurrency is the medium of exchange that secures financial transactions and transfer of assets. It is comparable to a bank note of which only the serial number has been kept and that can only be spent once.

In terms of benefits for consumers, Abdullah Han, co-founder of HLC, listed many advantages of the technology:

1. Trust: enabling trust through a distributed ledger system that traces cryptographically secure distribution and transfer of highly customizable, digitized exchange.
2. Cost-effectiveness: eliminating the middlemen through peer to peer transactions without the involvement of a third party which often limits investment accessibility by restricting investments to accredited investors only, demanding high fees and requiring an access to stock-trading accounts.
3. Market access & efficiency: investing in real world assets far more efficiently through blockchain asset tokenization. Tangible assets can be divided into small units increasing their liquidity and enabling more market participants to join. Tokenization has the potential of significantly impacting financial markets by lowering transaction costs, introducing programmable compliance, reducing settlement time and increasing potential liquidity. For investors, fractional ownership and lower barriers help them to increase portfolio diversification.
4. Immutable proof of ownership: Blockchains are immutable and keep a public trace of every transfer, and owner. This digital trace of transactions not only proves the history of ownership but also helps to ensure less fraud and falsification.
5. Innovation: despite blockchain technology’s numerous current limitations, it does give a new orientation to businesses and incite them to look for future-proof visions and community-driven business models.

In the case of Islamic finance, Mohamed Maher Mannai, Program manager of Islamic Financial Institutions at ICD, stated that blockchain technology and crowdfunding might help to tackle a set of unique issues and problems Islamic finance faces due to its infant stage of development (as compared to conventional finance):

1. liquidity management is one of the main issues of Islamic banking. Islamic banks cannot deal with conventional and central banks as they cannot exchange money for money. ICD previously launched a commodity murabaha system but it turned out that amounts exchanges did not involve real commodities. Blockchain solutions might help to manage liquidity through creating a digital platform exchanging commodities and asset backed financial products effectively and transparently;
2. clearing and settlement process: blockchain solutions could also facilitate connections among Islamic banks. There is a need to explore how a unified blockchain platform could make up for the current dismantled clearing and settlement process;
3. financial inclusion: more than half of ICD members are based within fragile economies where potential clients are not bankable. Crowdfunding can help foster innovative solutions to reach out to them.

Hubert de Vauplane explained that this decision is due to the fact that ICOs are a non-regulated option of raising funds circumventing public offerings’ regulations. In fact, crowdfunding and ICOs have had the same product life cycle : a craze period followed by a halt due to changes in regulations and then a product transformation phase. ICOs are now evolving into STOs  (Security Token Offering) and IEOs (Initial Exchange Offering) allowing greater transparency, greater regulatory clarity and lower risk. Despite becoming a short-lived method for raising funds, they certainly paved the way for a completely new model for projects to issue and sell tokens, that is here to stay.

At the institutional level, there are some interesting « Blockchain moves » in the Islamic region. Last January, the UAE and Saudi Arabia announced the launch of a common cryptocurrency called « Aber ». The currency “will be strictly targeted for banks at an experimental phase with the aim of better understanding the implications of blockchain technology and facilitating cross-border payments.” as stated by the central banks of both countries.

ICD whose mission is to enable and equip its members with the latest infrastructure and technologies has dedicated a team to research new technologies’ possibilities and applications’ feasibility. It is currently working on creating digital platforms that tackle the issues cited above. The bank is launching soon an Islamic Blockchain Academy to equip members with the technology. It is also building a powerful financial capability through a crowdfunding platform in collaboration with Bettervest. It aims at associating a network of 52+ member banks to work together to back projects in order to yield better results for SMEs and guarantee funds for crowds. ICD is also exploring the possibilities of a platform to exchange goods to proceed with commodity murabaha, as well as halal food blockchain.

As far as the private sector is concerned, other than crowdfunding platforms related to real estate seen as the sector most ripe for development, there are no major financial initiatives. Abdullah Han pointed out that there is not enough liquidity in the ICO/ blockchain market in the MENA region. It is a market where awareness about fintech is low and consequently chances to generate liquidity are as low. Local projects lacking local investors’ interest would have to look for liquidity in more mature markets.

When talking about blockchain currency regulations, a distinction must be made between virtual currencies that are issued by central banks and crypto assets that serve as public offerings vectors.

On the monetary side, international institutions issued memos that are not on the same page. The central bank of banks, BIS (Bank for International Settlements), is conservative concerning crypto, unlike IMF that encourages central banks to emit crypto currencies as it considers the crypto trend cannot be ignored. Most countries started regulating ICOs as well as the rest of blockchain financial products, especially countries with strict capital control like China and Morocco. The latter have firmly opposed security tokens whose primary role, consisting in increasing the fungibility and transportability of a physical asset, conflicts with their monetary policies.

As far as blockchain applications in Islamic finance are concerned, now that regulations expect tokens to be asset backed, Hubert de Vauplane pointed out that « tokenization is becoming relevant in Islamic finance ». « And there is no need for new Islamic regulation, what now matters is to use the blockchain technology to democratize existing Islamic finance tools ». The question is mostly about how to turn traditional funding tools into asset backed products that cut costs, foster inclusion and gain efficiency.

The applications are more relevant at the institutional level for the time being. Private sector cryptocurrencies are not going to emerge anytime soon. De Vauplane explained that for now, private sector coins are not as relevant as a crypto issued by an institution such as IsDB that can provide practical solutions with two major advantages:

1. traceability and sharia compliance control from financing lines deployment to local SME actual purchases ;
   
2. foreign-exchange risk decrease as the IsDB crypto could be a stable coin pegged to a basket of currencies or commodities.

Mohammed Maher Mannai confirms that there are no bold initiatives yet for the private sector. However he insisted that ICD is chasing any initiatives that can help SMEs and banks with increased digitization and access to funding or serve the ICD’s role to act as a bridge for SMEs to reach out to ICD’s members and the rest of the world.

Will Islamic regions’ private sector manage to innovate within the current regulatory frameworks or are local rules and governance definite roadblocks to innovation? Leave your comments below.