Blockchain chatter is everywhere, and there continues to remain confusion in the Islamic world.
We hope that by the end of this discussion, readers get an insight into blockchain and begin to realize the tremendous benefit this technological development could have on the Muslim world with a very direct impact on the Halal economy.
We will start by laying out the most fundamental element in any business transaction, which is interactions within the business community between buyers and sellers. As we conduct our transactions, we strive to follow Islamic principles in our interactions to the best of our abilities. These principles, which largely define the validity of any transaction in Islamic law can be summed up to the principles of fairness, justice and ethical practices.
The Quran, which is the primary source of Islamic laws, is emphatic in its instruction to believing Muslims to fulfill their contractual obligations and ensure fairness and justice in their dealings.
It says in Surah Maidah (Q5:1): “O you who have believed, fulfill [all] contracts.” In another part in Surah Nisah (Q4:58) it says: “Indeed, Allah commands you to render trusts to whom they are due and when you judge between people to judge with justice.“
In theory, these principles on one hand encourage the respect of agreements, fulfilment of obligations, and upholding of property rights; and on the other hand, discourage deception, corruption and other forms of unethical practices in business. However, the practice differs from the theory, leaving a gap that continues to grow as we interact more in business.
Principal-agent framework defined
A simple economic framework that may help us understand how core Islamic principles are either infringed or tolerated is the conventional principal–agent framework. This framework will further help to highlight the role of blockchain technology if adopted in a business transaction.
Let us consider the two key principles that the verses mentioned above are centered around: trust and contracts. In a transaction, both of these principles are the responsibility of the principal – anyone seeking a particular service; and the agent – anyone tasked to provide the service. This is depicted in Figure 1 with the definitions using the example of participants within the Halal economy.
Implicit in this transactional relationship between the principal and agent is the issue of information asymmetry, which results in underlying risks that include moral hazard and adverse selection – as depicted in Figure 1. These risks can be managed in two ways: screening or signaling. Both these risk management methods carry obvious costs that are both tangible (monetary loss) and intangible (oportunity cost) in nature.
Risks: What are the risks?
- Adverse selection: Potential opportunistic behavior of the trusting Halal agent (THA). When the trusting Halal principal (THP) selects a THA – the potential risk of selecting an unwanted partner. Certain hidden characteristics of the THA are not known to the THP before a contract is signed.
- Moral hazard: If information asymmetry occurs after a contract closes (ex-post), the risk of moral hazard arises. THP has insufficient information about the exertion level of the THA. External effect such as environmental conditions can also influence the THA action.
Risk mitigation: How do you mitigate the perceived risks?
- Signaling is a strategy for the THA to communicate its very nature and true character. In order to achieve this, the THA provides proof of certification or other transparent measures to the THP.
- Screening is applied by the THP to identify the true nature of the THA, however, screening is valid only the THA has valid signals i.e., the THA actually owns the signal.
Figure 1: General principal-agent framework
ROLE OF BLOCKCHAIN TECHNOLOGY: GENERAL CASE FOR THE HALAL ECONOMY?
Blockchain which is a distributed network of computers ultimately eliminates the need for the information asymmetry costs to either the principal or agent. We will not argue that cost is necessarily zero; however, it can be argued intuitively given how blockchain works via a trusted distributed network that manages transactions that no one person can violate the trust established by the network. The network is essentially self-regulated and any obscure and/or transaction which allows someone to cheat gets picked up immediately. By reducing the inherent risks that the principal and agent face, the intangible (opportunity cost) and/or tangible costs to verify identities or payment etc, can be eliminated theoretically to zero. Hence the underlying value of blockchain is not only efficiency but the added benefit of automatic trust and contract fulfillment.
Enough of the theoretical background – what about its application in the Muslim world or more directly in the Halal economy? We have taken the liberty of adapting the principal agent framework in Figure 2 for the interaction between a Halal food manufacturer who needs to establish trust in its product by securing a Halal logo (from the Halal ministry/government body). We are depicting the various parties involved before the Halal retail buyer (HRB) who ultimately purchases a food product.
Across the chain of interactions there are various contractual obligations before the HRB makes a purchase which is driven by only one factor: the Halal logo, the trusted logo. The HRB is making an inherent assumption that all the contractual fulfillment has happened.
Figure 2: Principal-agent interactions for Halal food
A. HFP needs a bona fide unadulterated approval from HM; HM need to deliver an authentication stamp saying Halal to HP.
B. HFP distributes Halal products to HDR; HDR pays HP
C. HDR provides Halal Products to HRBs
D. HRBs have bona fide feelings that Halal stamp is authentic
Moral hazard: The entire value chain reeks of moral hazard problems due to self-interest. Perhaps the only entity relying on a bona fide response is the end buyer who is likely making a purely unadulterated decision purely based on trust via the actual Halal logo.
Use case: Blockchain in Halal food sector
Is blockchain the silver bullet to all problems that might exist in the sector? How does blockchain solve this problem? Consider Figure 3 where a potential blockchain solution is depicted to address the problem of information asymmetry. It does so by allowing the end buyer to verify that the entire value chain is compliant with Islamic requirements and limits the amount of potential fraud.
Let’s say a producer has completed the manufacturing process for the Halal food, say beef, and is now ready to deliver to the market. Before the physical transaction or shipping of the product, the manufacturer will perform certain Halal compliance and authentication measures (ie Halalticate) as part of the due diligence. Only after such due diligence will the product be eligible for the Halal logo, which is a mark of trust signaling to the retail consumer that the product is good and ready for consumption.
However, the process is still tainted with smidges of information asymmetry and risks, which leaves the consumer in doubts if not dismayed. Such risks can be managed by adopting either of the two methods presented in the principal-agent framework: screening and signaling.
Applying the screening method allows the consumer to verify the products authenticity in such a way that guarantee genuity and satisfaction. This is where the blockchain technology comes in handy as it presents the possibility of a detailed trail of the beef and enables anyone to trace the movement of the beef, right from its grazing ranch to the abattoir and down to the retail seller.
Signaling comes from the producer – the critical signal being that they have the food certified via the appropriate HM. Again, blockchain technology comes very suitable in securing and preserving such signals, making them tamper-proof for the general public.
Combining both method in a single platform and powering its application using blockchain technology will provide the trust needed in the transaction and eliminate the information asymmetry problem and its associated risk. Consider a simple illustration below:
- The Halal food manufacturer uploads product particulars alongside certification from respective issuing authority to a blockchain platform, Halalticate;
- The platform registers the product, and generates an immutable digital footprint using the product’s description and Halal particulars in its blockchain database. The digital footprints will be in form of Unique IDs in various forms (Alphanumeric code, along with secure pattern, QR code, bar code or short links) for an individual product, batch or category;Manufacturer attaches the Unique IDs to the product label and starts shipment.
- On the other hand, the Halal customer who is about to purchase the product would verify the authenticity of the product in the following steps:
- The customer looks up the product’s unique (Halal) IDs;
- Customer sends at least one of the unique IDs to the Halalticate platform for verification using a mobile device via SMS, QR scan or NFC facility;
- The customer receives an instant report and audit trail on the product (with detailed product description and Halal particulars).
Figure 3: Blockchain model
As the Muslim world gears up for the global Halal agenda and moves toward setting up a unified global Halal standard body, the role of technology cannot be over emphasized. Given the exponential rate at which technology is both developing and evolving, and the growth pace of the Halal economy, such solution based on blockchain technology is both timely and well placed.
We have discussed a conceptual background and highlighted a potential use case for blockchain which can have a major impact on transactional activity of food distribution in the Islamic world. The Halal food market is worth over US$1.3 trillion – and Muslims cannot take Halal logos at face value. Given the importance of trust and contracts in Islamic principles blockchain has a very direct impact on such principles. Blockchain will prove to be an automated approach allowing Muslim buyers to feel secure in their purchases while holding fraudulent transactions to task.
Under no circumstances is implementing a blockchain solution trivial – it will require considerable thought followed by execution and implementation. We anticipate that consensus building will also be tricky across different markets/regions. What is critical is that technology tends to typically lead policy/regulatory decisions. With that said it’s an interesting time for entrepreneurs who want to leverage blockchain to solve some of the challenges in the Muslim world. One major adjustment will be required and that will involve policy makers rethinking centralized control vs decentralized control – this may be a hard pill to swallow for many policy makers. Blockchain’s inherent capability is that it is self-regulated ie self-audited. Will policy makers in the Muslim world be able to adjust to such a thought process?