Cryptoassets are key to the future of finance
Crypto has moved from the fringe of fintech to become one of the fastest-growing sectors in finance. Venture capital funds invested over US$30 billion into crypto investments in 2021. The total value of global crypto-related mergers and acquisitions increased from about US$1.1 billion in 2020 to some US$55 billion in 2021 although the total crypto market cap remains smaller than the US$3 trillion-plus Islamic finance sector at around US$1.85 trillion[1]. Within crypto, the decentralized finance (DeFi) sector is still comparatively small at around US$200 billion of ‘total value locked’ in smart-contract-based protocols worldwide, leaving vast potential growth ahead.
How much of this venture funding was explicitly for Islamic or Halal crypto projects? Stats are hard to find but I estimate it is less than US$10 million, despite the US$3 trillion-plus evidence of Shariah-sensitive finance demand. As an active angel investor and start-up advisor, I have been on both sides of the fundraising table and there are still many challenges when it comes to funding for the Halal tech sector and on top of these, crypto investing is even more risky with a much higher incidence of poor governance, scams or failed projects, making it a minefield for investors especially on projects where sometimes founders and scholars bizarrely remain anonymous.
After 25 years in finance and markets, I genuinely believe that — for the first time in the centuries since interest-based, centralized banking was introduced — blockchain and the associated cryptocurrency technology offers humankind a real prospect of taking finance closer to the communities it is meant to serve with a new decentralized approach, but what exactly is DeFi?
DeFi 101: Cryptocurrencies are critical
It is ironic that central banking — core to almost every capitalist economy in the world — is actually a key pillar of Marxism/communism. Simplistically, it is a state-run monopoly in the business of money that persists even though the decentralized private sector tends to be much better at delivering innovation, efficiency, quality and economic value/wealth creation. Bitcoin is the first and still most decentralized (and hence neutral) cryptocurrency whose value is completely immune to monetary abuse, devaluation and political weaponization. Currently, institutional bitcoin trading volumes account for 99% of transactions over US$100,000 and it remains the cryptoverse equivalent of gold or a ‘reserve asset’ that will continue to appreciate over the long term while the fiat money inevitably devalues.
Cryptocurrencies are critical to the functioning of any DeFi ecosystem as it allows financial settlement to occur directly within a set of financial ‘smart’ contracts with immense efficiency, cost, transparency, audit and compliance benefits. With respect to Shariah, some scholars have noted that technology of cryptocurrencies/coins/tokens and their associated blockchains are intrinsically Shariah-neutral but the source of a coin’s value needs to be fully assessed to ensure a token is Halal or Haram given the prevalence of interest-based lending in the cryptoverse. This is a view I personally support — one Fatwa does not fit all.
2021 was the year the crypto finally became institutional as inflows hit US$9.2 billion to push the crypto assets under management to US$62.5 billion. Indeed, the CEO of DBS Bank, a US$700 billion Singaporean centralised finance (CeFi) titan, recently shared his belief that: “Bitcoin will continue to grow as a meaningful store of value in a similar vein to gold.” It is important to note that cryptocurrencies are equally useful in both CeFi and DeFi which explain why many of the world’s largest banks have collectively invested US$3 billion into crypto and blockchain technologies. Emerging market leader Standard Chartered leads the pack with US$380 million invested and is joined by CeFi powerhouses JPMorgan, Goldman Sachs, Santander and Citibank among others, all investing hundreds of millions each. Where are the Islamic Banks?
DeFi is a true use-case of blockchain, smart contracts and cryptocurrency technologies
Blockchain technology is specifically suited for Islamic finance which is ideally asset-backed, although in substance current practices tend to fall short of the ideal given customer demand. Islamic business principles around transparency, fairness and the binding contractual agreement between parties fit perfectly with this new technology. In addition, DeFi crucially relies on smart-contract technology to enable peer-to-peer trustless financial activity and can economically liberate individuals to become entrepreneurs, investors or even collectively their own ‘bank’.
Smart contracts can incorporate the entire financing structure, contract, underwriting risk and compliance processes into the ledger of second-generation blockchain solutions. The various nominal contracts used in Islamic finance (for example Ijarah, Mudarabah, Salam and Murabahah) can also be automated through smart-contract logic together with the relevant tokenized assets.
Regulations and processes involving know-your-customer, anti-money laundering and consumer protection can be codified into smart contracts. As such, it is entirely feasible in the future to have an Islamic ‘decentralized bank’ operating profitably in the metaverse that is funded, owned and collectively run by their communities allowing people to transact with no intermediaries and no discrimination.
However, while crypto exchanges report growing transaction volumes of tens of billions of dollars every day, millions of Halal-sensitive Muslims remain shut out of this ecosystem because of the fear and confusion of cryptocurrency being prohibited or ‘Haram’ given the wide diversity of opinion among scholars.
The Islamic crypto economy has barely begun
Currently, it is observed that no Islamic bank is yet offering crypto assets to retail customers — which may make sense given the high-risk aversion and current profitability of their existing business. Nonetheless, various crypto and DeFi platforms are emerging to attract the younger stakeholders of billion-plus of Halal-sensitive consumers as well as those looking for a more ethical approach. Halal crypto will ensure that the community will be a part of this new high-growth economy that will create many new jobs and businesses globally. As such, it is important to remove the confusion and friction around the ‘Haram’ perception of crypto in some quarters so that Muslims can enter this space with a clear conscience.
While still very immature, DeFi platforms hold huge promise. The most prominent Islamic platform is currently MRHB DeFi[2] (‘Marhaba’) which raised over US$5 million[3] from the community in December 2021 to build an entire, eight-product Halal cryptoverse that includes non-interested based lending, non-fungible token market and crypto income products. The telegram community has over 45,000 of mostly millennials and Gen Z members across five languages and has a Shariah governance board that has a key role in the design of the products and not just certification. MRHB may potentially (in future) apply a decentralized governance model to give token holders direct power to determine the direction and conduct of the ecosystem and enable more autonomous decision-making. (Disclosure: Acreditus Partners, founded by the author, is a strategic shareholder of MRHB.)
Shariah governance is challenging in this fast-growing space with only a handful of scholars currently fluent in crypto. Perhaps to reduce this bottleneck, maybe it is best in the future if Shariah compliance can be devolved to a decentralized body of scholars who through the use of specialized Shariah governance tokens can ensure the Halal integrity of the platform. This perhaps befits a faith that has multiple schools of Shariah jurisprudence and no centralized institutional authority to dictate compliance and hence is itself somewhat decentralized (with the strengths and weaknesses this entails).
Can DeFi drive greater financial empowerment for everyone?
The benefits of DeFi extend far beyond Islamic finance. Following the 2008 global crisis and then the COVID-19 pandemic, there is a widespread perception that the centralized financial system is failing the needs of the ‘99%’. Financing of the economy seems far more lucrative than the real economy and money printing is driving yet more inequality. Economic growth is still greatly dependent on Riba/interest-based, debt-fueled consumption rather than productive investment and ‘stagflation’ (low growth and high inflation) is a distinct possibility. Given this sorry state of affairs, one can argue that our centralized finance is already failing younger and lower income populations worldwide and many Muslim communities in particular are particularly vulnerable to exclusion.
At its ideal, DeFi will allow communities to build multiple self-sustaining ecosystems that allow individuals to better manage their own financing, wealth and assets without centralized institutions sitting in the middle, slowing the process and extracting fees. More specifically, it allows the more socially conscious to build a more accessible, fairer and ethical or Halal crypto platform that is governed according to their community values. DeFi ecosystems can better support the needs of local communities versus the one-size-fits-all macro policies to really devolve economic and entrepreneurial wealth creation to the lowest levels of society. Crucially, decentralization is also one way to prevent racial and religious discrimination in financial access.
Clearly, this is just the beginning of ethical and Halal DeFi and there are still many risks in such an infant technology. However, with over three trillion dollars of assets in the Islamic finance sector, there is room for many Halal crypto platforms focused on this community and ensure they are not left behind. The focus on Halal ethics has generated significant interest from those who remain excluded due to [justifiable] fear and cynicism and — if done right — Islamic DeFi can bring the mainstream population safely into the cryptoverse.
Khalid Howladar is the chairman of MRHB DeFi, partner and founder of Acreditus Partners and head of credit/Sukuk at RJ Fleming & Co.
[1] https://coinmarketcap.com/ 20/03/2022
[2] MRHB DeFi currently has a community numbering 50,000 over various channels of which 1,000+ invested in the various funding rounds typically reserved for VCs and HNWIs. The token launch was on 22 December 2021 more information here CoinMarketCap and is listed on LBank and PancakeSwap
[3] https://www.globenewswire.com/news-release/2021/12/31/2359462/0/en/MRHB-DeFi-Closes-Successful-USD5-5M-Fundraise-with-IDO-and-Announces-5-Million-Pool-of-MRHB-Token-Rewards-for-Liquidity-Providers.html