Jubran Siddique, Founder and CEO at Zaryah Investment Company.
As the internet ushers in the Web3 era, it appears poised to deeply impact the $4 trillion-dollar Islamic finance industry (also known as Shariah-compliant finance). I see asset tokenization, in particular, as having the potential to revolutionize the sector by increasing asset accessibility and fostering innovative financial products in line with Islamic law principles.
BCG’s recent research report discloses that a significant portion of global wealth is locked in illiquid assets. These assets often trade at a discount compared to liquid assets due to their high stock-to-flow ratio, lower trading volumes and imperfect price discovery. Illiquid assets encompass real estate, natural resources, land, commodities, public infrastructure, fine art, computing infrastructure and private equity.
I believe on-chain asset tokenization offers a solution to many barriers associated with asset illiquidity and the limitations of traditional fractionalization. Further, appropriately leveraging blockchain technology and asset tokenization can help us reimagine the end-to-end process of identifying and matching investors with investment opportunities and facilitate secondary market opportunities post-investment.
Applications For Tokenized Assets
Tokenized assets are generally classified into two types: fungible tokenized assets, which are interchangeable and divisible and nonfungible tokenized assets, which are unique and noninterchangeable. Fungible tokenized assets include fiat, tokenized securities and gold, while nonfungible tokenized assets comprise vintage paintings, housing property and collectors’ cards.
Tokenization In Islamic Finance
Tokenization has multiple applications in Islamic finance. For instance, it can transform the realm of real estate investment. Traditionally, investing in real estate has been restricted to those with substantial capital, leaving the average investor with limited options. Tokenizing real estate assets, however, can allow investments to be divided into smaller units and traded on blockchain platforms, inviting participation from a wider investor pool. Emerging Shariah-compliant platforms facilitate real estate asset tokenization through profit-and-loss sharing (PLS) structures.
Some hurdles to tokenized finance in ensuring Shariah compliance include the prohibition of interest (Riba), the avoidance of excessive uncertainty (Gharar) and ensuring adherence to risk-sharing principles.
Here are some tips that can help you overcome these hurdles posed by tokenization.
1. Have access to Shariah scholars who have exposure to Islamic fintech so that you can consult with them and ensure the tokenization process and the underlying assets are in compliance with Shariah law.
2. Make sure that all the relevant information about the tokenized asset is available to potential investors.
3. Use Shariah-compliant profit-and-loss sharing (PLS) structures, such as Mudarabah and Musharakah, to ensure investments align with Islamic risk-sharing principles.
Tokenization And Crowdfunding
Crowdfunding is another area where tokenization can prove to be beneficial. Tokenization can create blockchain-based crowdfunding platforms that seamlessly comply with Islamic law principles.
These platforms support the issuance of Sukuk, Islamic bonds adhering to risk-sharing regulations, and are utilized to raise funds for various projects. Tokenizing Sukuk permits easy trading and division into smaller units, enhancing accessibility for a more diverse range of investors. This, in turn, can lead to heightened market liquidity and more efficient price discovery.
Finance professionals should keep the following aspects in mind when it comes to this practice.
1. Ensure that you adhere to local and international regulations governing Islamic finance and crowdfunding, ensuring the tokenization process is compliant with both financial and Shariah laws.
2. Maintain transparency in the issuance and trading of tokenized Sukuk, providing investors with clear information about the underlying assets, risks and Shariah-compliant structures.
3. Partner with established Islamic financial institutions to facilitate the issuance and trading of tokenized Sukuk, fostering trust and credibility in the market.
Tokenization In Mudharabah Structures
Tokenization can also be applied to Mudharabah (partnership) structures, where investors supply the capital to a business in return for a share of the profits. Emerging platforms are enabling Shariah-compliant business tokenization, allowing a broader range of investors to engage in partnerships. Moreover, blockchain technology can assure transaction transparency and security, simplifying compliance tracking and adherence to Islamic law.
Some ways that tokenization can be applied to Mudharabah include:
1. Tokenizing shares/equity of a company so that businesses can allow investors to buy and sell shares more easily, enabling increased liquidity and investment flexibility.
2. Utilizing blockchain technology to track and record transactions, profits, lines of credit, bank guarantees and other real-time information to all stakeholders.
3. Leveraging tokenization to streamline the fundraising process, allowing businesses to connect with potential investors more efficiently and securely. You can also use this process for decentralized autonomous organization (DAO) offerings where the shares can be issued as initial DEX offerings (DEOs).
Larger Implications
The ongoing transition to the Web3 era offers substantial opportunities for Islamic finance. But this shift toward tokenization is not exclusive to this sector; it is part of a larger trend in the global financial sector.
By leveraging the transparency, security and efficiency provided by blockchain technology, I believe that asset tokenization can pave the way for a more inclusive and robust financial ecosystem that benefits a diverse range of investors and stakeholders.
Looking To the Future
Although the full potential of asset tokenization in Islamic finance remains to be seen, I think early indications are promising. As new platforms and products emerge, those of us in the industry must continue to adapt and innovate to harness the power of blockchain technology and capitalize on the opportunities offered by the Web3 era.
By doing so, we in the Islamic finance sector can position ourselves for substantial growth and contribute to the development of a more equitable and sustainable global financial system.
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