Technology and Financial Disintermediation with a Special Reference to Blockchain and Islamic Finance
Creators: name: Kasujja, Kabuye Mahawuya
Publisher: name: Manara - Qatar Research Repository
Year: 2024
Subjects: classificationCode: 50
subject: Philosophy and religious studies

description: The global economy is rapidly becoming digitalized, especially with the growth of intangible digital assets such as data, knowledge and information, patents and trade designs, art, entertainment and media, virtual property and cryptocurrencies among others. Since these are intangible digital assets, they can be copied infinitely, which poses a basic problem characterized as “double spending” during the process of the value transfer. The use of a trusted third party intermediary with centralized-ledger to prevent the problem of double spending during the value transfer of these digital assets is no longer effective. The alternative is a Peer-to-Peer distributive-ledger. The underlying technical infrastructure has come to be known as Distributed Ledger Technology (DLT), motivating innovators to come up with the Blockchain as an implementation of DLT in order to address the trust problem. The purpose of this thesis is to explore and understand the intentions of the innovators and the value propositions of DLT through summarizing the technology whitepapers for some of these DLT platforms and how these can be of benefit to Islamic finance. The DLT studied in this thesis include public blockchains such as; the Bitcoin protocol and Ethereum. We have also studied a practical Ethereum based application of a string smart contracts known as the Decentralized Autonomous Organization (DAO) which if improved to avoid past governance mistakes and properly regulated may have potential applications in profit and loss sharing modes of Islamic finance such as <i>Musharaka</i> or it may be useful in future <i>sukuk</i> issuance; a potential example suggested in this research. For the permissioned DLT studied in this paper, we have looked at the Ripple Protocol Consensus Algorithm (RPCA), R3 Corda and Hyperledger Fabric protocols. Further to the permissioned DLT, we have also reviewed the value propositions of an alternative DLT implementation called the Hashgraph protocol that promises viable solution to the Blockchain’s scalability issues. For Islamic finance to benefit from this technology, some of the challenges that may have to be addressed before the technology’s adoption have also been highlighted in this thesis. Since one of the intentions of DLT is to ensure a peer to peer transfer of value without any trusted intermediary, we have also studied this technology’s impact on financial intermediation and how it has led to financial disintermediation. To gain a better understanding of financial disintermediation, we have explained why financial intermediaries exist and why financial intermediation is important in the current financial industry setup.The legality of the use of the Blockchain was also recently questioned in light of the recent findings by some German researchers who discovered that links to harmful material such as pornography including in all its forms was being spread knowingly or even unknowingly by users on the Blockchain. The use of the Blockchain as a Trojan horse for illicit materials definitely raises a red flag for regulators and also calls for further scrutiny from both the <i>Shariah</i> and moral perspective. Also from regulators’ and <i>Sharia</i> perspective, the discussion has mainly been driven by the legality and acceptability of the virtual currencies on the Blockchain as a form of currency. Most of the regulators have not accepted virtual currencies as a form of currency because it is not legal tender and thus a cautionary approach has been taken by most to ensure financial stability in their respective jurisdictions. However, there is a growing consensus among regulators in regards to private Initial Coin Offerings (ICOs), to treat these virtual currencies as securities rather than as a form of currency. This is because the technology has proved to be very popular and presents very big potential for ICOs and crowdfunding. Banks have also quickly jumped on to the bandwagon with most of the big banks partnering with technology innovators such as R3, Linux and IBM to create and simulate banking operations and potential application on the Blockchain. When it comes to Central Bank issued Digital Currencies (CBDCs), the gradual approach most favorable and recommended for the current monetary system is for the central banks to facilitate a payment system between itself and commercial banks. A CBDC accessible to the general public has been discouraged because in times of financial stress depositors will opt to put their funds in CBDC instead of depositing them with commercial banks which leads to a disruptive form of disintermediation. Such a CBDC may also create potential challenges for the central bank in its traditional role of transmitting its monetary policy effectively across the economy.<br>