Blockchain & Islamic Finance

Blockchain & Islamic Finance

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  By Dr FarrukhHabib Blockchain and Islamic Finance Researcher and Advisor
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  How Did Blockchain Start? •History of Blockchain • Developments in Blockchain What is Blockchain? • Components of Blockchain • How Does Blockchain Work? Characteristics of Blockchain • Why Use a Blockchain? • Where Blockchain cannot be Used? Blockchain in Finance • Blockchain for Finance • Use Cases of Blockchain Blockchain in Islamic Finance • Islamic Trade Finance & Blockchain Section 1 Section 2 Section 3 Section 4 Section 5 What We Are Going To Learn Today? Let’s see…
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  1989 1996 1998 2009 2011 HistoryofBlockchain DigiCash • Introduced byDavid Chaum • Centralized but anonymous encrypted system • Faced strict regulatory requirements B-Money • B-money by Wei Dai • Anonymous, based on proof of work system • Only a concept, never deployed Bit Gold • Bit gold by Nick Szabo • Anonymous, distributed, based on proof of work system • Failed to attract the attention of the community Bitcoin • Bitcoin by Satoshi Nakamoto • Anonymous, distributed, based on proof of work system • Successfully deployed Altcoins • Emergence of Namecoin, Litecoin, Peercoin, etc. • Different from Bitcoin in some features • Started the boom of crypto-assets
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  1983 1991 1992 1996 2005 2009 “Blinding” algorithm was created byDavid Chaum using cryptographic encryption technique to achieve anonymity of the transacting parties Stuart Haber and W. Scott Stornetta introduced the concept of cryptographically secured chain of data blocks Wei Dai introduced the concept of solving computational puzzles, Hashcash, as proof-of-work (POW) with the decentralized consensus algorithm for a digital money system Bayer, Haber and Stornetta incorporated Merkle trees to the design improving its efficiency by allowing several documents to be collected into one block of data Hal Finney introduced the concept of “reusable proof-of- work” to create a cryptographic digital cash system, but it was not decentralized Satoshi Nakamoto effectively used POW at a decentralized platform for a cryptocurrency and successfully deployed the algorithm Technical Developments in Blockchain
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  Blockchain Explained What isBlockchain? Blockchain is a decentralized digital ledger technology to record anything of value. Main Components of Blockchain: • Public Key & Private Key: to create a secure digital identity reference • Digital Ledger: the shared contents and databases available to the participants of a particular Blockchain Ecosystem • Node Application: every computer needs a node application specific to the blockchain ecosystem that it wants to participate in • Consensus Algorithm: it depicts status of the network and how the nodes in the network arrive at an agreement regarding what transactions to accept • Virtual Machine: to run the node application on a computer
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  The requested transaction isbroadcast to a P2P network consisting of nodes. The nodes validate the transaction using known algorithms. Once verified, the transaction is combined with other transactions to create a new block of data for the ledger. The new block is then added to the existing chain of blocks. The transaction is complete and verified. Transaction Initiation Broadcasting & Validation Block Creation Block Addition Completion How Does Blockchain Work? Someone requests a transaction from another party.
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  Decentralization Secured Immutability Transparency Efficiency Decentralization is one ofthe most critical features of Blockchain Technology which is the reason of many of its strengths. The data on blockchain is highly secured, trusted and safe. . None of the previous entries in the ledger could be modified in any way. Whole transactional data is readily viewable and traceable by all parties ensuring high level of transparency. The fastest ways to transfer value across the globe. No intermediaries are required. Main Features of Blockchain
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  Many legal, regulatory and governance issuesneed to be resolved before blockchain could go mainstream. The features of transparency and traceability can be considered as strengths, but privacy issue might be a huge problem. Since the technology is still new, the changes of human error, security flaws and bugs are and will be, there. Due to lack of expertise, developing or coding blockchain algorithms seem to be highly complexed. If the network is not robust with widely distributed nodes, it becomes more difficult to reap the full potential. Scalability Complexity Human Error Privacy Regulations Limitations of Blockchain
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  Audit & Compliance Data Management Speed & Simplification Achieving Efficiency Cost Saving Dueto strong transparency and traceability features, blockchain can offer more convenient ways to perform proper review and audit. It can also improve solutions to compliance issues. The transfer of value has always been an expensive and slow process. This is particularly true for cross-border payments. Blockchain technology is able to speed up and simplify this process. Blockchain technology can offer more secured and safer transactions, hence more reliable. Overall, the data processing, sharing and management can be much more efficient. Blockchain projects have the potential to reduce, and possibly eliminate, settlement times due to their digital nature, ensuring the timely and secure processing of banks’ operations. Banks are dealing with rising costs for maintaining or replacing their aging infrastructure and ensuring compliance with heavy regulatory burdens. blockchain-based solutions could generate cost savings of up to $20 billion per year, according to Santander. What can Blockchain Offer to Finance?
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  Smart Contracts Decentralized Apps Identity Management Use of APIs Crypto- Assets A smartcontract is a computer protocol intended to digitally facilitate, verify, or enforce the negotiation or performance of a contract. They allow the performance of transactions without third parties. This feature will enable financial institutions to perform credit check and validation through electronic KYC. The same data can be shared, processed and managed for various purposes. Digital computer applications which are both decentralized and distributed can hugely improve quality of financial services. These applications can be developed for various financial services and processes. In computer programming, an application programming interface (API) is a set of subroutine definitions, protocols, and tools for building application software. In general terms, it is a set of clearly defined methods of communication between various software components. A cryptocurrency (or crypto- asset) is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions, to control the creation of additional units, and to verify the transfer of assets. Blockchain Features for Finance
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  Use Cases ofBlockchain in Finance Life Term Insurance A life term insurance product can be recorded in a blockchain technology smart contract. Insurance is a logical fit for self- executing smart contracts, since the conditions that lead to a payout can often be clearly defined beforehand in the insurance policy. Share Trading Share trading will change even more dramatically. Blockchain technology can not only cut out brokers, but the stock exchange itself could also become decentralized, without a central system being required to bring supply and demand together. Cryptocurren cy Exchange There is a problem of exchanging the cryptocurrency back into locally accepted (fiat) money at the destination. Due to extra complexity and risk of fluctuating exchange rates , financial institutions can tap this market. The numbers of entrants have the potential to go up once more beneficial regulations are developed. E-KYC Users only have to identify themselves once to one of the banks or insurance companies connected to this platform. The fact that they have been identified by one of the parties is then recorded on the blockchain, so they do not need to be registered by the other parties as well. Loyalty & Reward Loyalty & rewards programs can be developed on the blockchain. The coins generated could be used to enhance e.g. regulatory compliance. They can be a reward for employees who share knowledge, fill out time sheets in time, or visit certain events and take courses. Use Case 1 Use Case 2 Use Case 3 Use Case 4 Use Case 5
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  Some of theLargest Blockchain Projects Trade Finance Platform • Using IBM’s Hyperledger Fabric aimed at international payments utilizing blockchain • Partners include Deutsche Bank, HSBC, KBC, Natixis, Rabobank, Societe Generale and Unicredit Utility Settlement Coin (UTC) • A tool for more efficient transactions, addressing the issues of currency backing, default and credit risks • Partners include Barclays, CIBC, Credit Suisse, HSBC, MUFG, State Street, UBS, BNY Mellon, Deutsche Bank, Santandar R3 Consortia • To develop infrastructure network, Corda platform, for financial institutions to build their own ledger- based applications and services • Partners like Temasek, SBI Group, Bank of America, Merrill Lynch, Intel, Wells Fargo, ING and many others have raised USD 107 million in May last year
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  Data-Driven Decision Making Payment Systems Digital Assets Trading Supply Chain Smart Contracts Data-driven decision making(DDDM) is an approach to business governance based on verifiable data. This approach can be utilized in sharia governance, VBI system, and corporate decision making. Sharia compliant assets, like sukuk, securities, commodities, real estate, etc. can be digitized and traded on the blockchain platform. Many Islamic products for payments, and the payment systems themselves can be introduced and improved by blockchain. Blockchain can be used to track the origin of goods and commodities, their movement and transfer of ownership to facilitate Islamic financial transactions. Sukuk, sharia compliant securities, Islamic financial products and services, or any kind of business logic relying on data can be coded by way of smart contracts. Blockchain in Islamic Finance
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  1 2 34 5 6 7 8 Invoice Factoring - Use of invoices for achieving financing from multiple banks - Risk of delivery failure Manual AML Review - Manual AML checks using the financials provided by the import bank Duplicate Bills of Lading - Multiple financing of bills of lading due to lack of robust verification process Delayed Payments - Multi-parties verification for funds transfer to the importer Manual Contract Creation - Manual review of agreement - Sending financials to the correspondent bank Delayed Timeline - Numerous checks by intermediaries and communication points - Risk of delayed timeline Multiple Platforms - Different parties use different platforms - Risk of miscommunic ation and fraud Changes in Financials - Financials are exchanged among different parties - Changes could be made during the process Today’s Trade Finance (Main Pain Points)
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  1 2 34 5 6 7 8 Realtime Review of Agreement In real-time, the import bank will have capability to review purchase agreement, draft terms of credit and submit obligation to pay to export bank Digital LC Signing After receiving the obligations, the exporter will digitally sign Blockchain- equivalent letter of credit within the smart contract to initiate shipment Transportation of Goods During transit, goods will be transported from Country A to Country B Automated Payments Using provided acknowledgement , Blockchain will automate payment from importer to exporter via a Smart Contract Creation of Smart Contract Upon purchase, the agreement of sale between the importer and exporter is shared with import bank using a Smart Contract on the Blockchain Smart Contract for T&C Export bank will review the provided payment obligation and once approved, a Smart Contract will be generated on the Blockchain to cover terms & conditions and lock-in obligations Digital Validation of Inspection Goods will be inspected by 3rd parties and the customs agent in the exporting country - with all providing their respective digital signature of approval on the Blockchain smart contract Digital Acknowledgement Upon delivery, importer will digitally acknowledge receipt of goods and trigger payment Blockchain in Trade Finance
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  The Way Forward NoMore Imitation Game! Changeof Mindset Most importantly innovative thinking, creative implementation, daring approach is crucial in the recipe of success. Research& Developme nt More serious and in-depth research and development is needed in the areas, sharia, regulations, legal, governance, etc. Sharia Compliant Crypto-Assets Halal-Chain coin, OneGram, GoldX have already been launched. More crypto- assets will come soon. The Islamic finance ecosystem could leverage on it to exponentially enhance business processes and streamline operations.A Revolution
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  Allah Knows Best! TheEnd Questions? Or Comments? Dr Farrukh Habib [email protected]