WILL SMART CONTRACTS ELIMINATE THE NEED FOR SHARIAH ADVISORY?

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Author: ALKHAZUR TAZBAEV

Nowadays, we are living in the Fourth Industrial Revolution era (4IR). “Industry 4.0” is totally based on technology, and it’s described as revolutionary because of its use of ongoing automation of many industrial spheres via implementing modern smart technologies. This revolution consists of many technologies, such as Artificial Intelligence (AI), Internet of Things (IoT), digitalization of products and services, digital business models and so on. As a result, traditionally split spheres have merged to create new concepts of BioTech, EduTech, AgroTech, etc. In the financial sphere, we have FinTech where technology meets finance with integrated blockchain systems and widely used smart contracts.

Many describe the use of blockchain technology in FinTech as a disruptive technology that is designed to revolutionise financial intermediaries. Despite the ongoing debates around this description, the technology itself is becoming attractive and tempting in terms of reducing costs and elimination of certain types of financial intermediary services. In this context, the following question arises: will the various types of advisories, including Shariah advisory, be eliminated by the use of smart contracts?

In our attempt to answer this question, we need to define what a smart contract is. A smart contract, as defined in Investopedia, is a self-executing contract with the terms of the agreement between a buyer and a seller being directly written into lines of code. A smart contract records the terms of a contract between Ahmad and Aisha on a distributed and decentralized ledger, (that is a blockchain network), shared between all participants in the network and validated by them. From the definition of a smart contract, we clearly see that for a smart contract to be coded and written on the blockchain system there is a need for another, preliminary contract. In other words, to execute a smart contract, parties must first negotiate the terms of their agreement until they reach a “meeting of the minds.” Obviously, this preliminary contract, as well as the following smart contract that represents the first one, both of them have to be Shariah compliant.

The practice of transactions in Fintech applications generally and blockchain based smart contracts particularly, should follow the rule of contract (‘aqd) used in the transaction by observing the pillars (Arkan) and conditions (Shurut) in the contract. Besides, all kinds of contracts should observe Islamic ethics such as transparency, fairness and justice, while avoid cheating, fraud, misrepresentation and other similar actions. To say the least, offer and acceptance, coupled with consideration, are still the basic principles of contracts, whether they are smart, oral, written or digital. Consequently, smart contracts cannot eliminate the need for Shariah advisory.

In addition to that, if we look at smart contracts from the technical aspect, we can see that smart contracts have a very simple formula known in programming as the “if”, “then”, “else” rule. In other words, the smart contract is structured in a very logical way of conditionals: “if” something happens, “then” do something “else”. That explains how a smart contract is automated. Indeed, many terms and conditions that a usual contract consists of are more than just logic. If some operational clauses within legal contracts can be fully automated, other non-operational ones, for example, governing law clauses, are less susceptible to being expressed in machine-readable code. At the same time, some legal clauses are subjective or require interpretation. However, not all contracts need to be automated.

Furthermore, if the subject matter are financial products that have complex and intricate structures, the need to a Sharia adviser increases exponentially. For instance, there is a tendency nowadays to issue blockchain-based sukuk, and the structure is generally built on using smart contracts to automate the processes. It’s true that the use of this technology reduces a lot of costs by removing some intermediaries from the process of sukuk issuance. However, the financial cost involved in obtaining services of the Shariah adviser cannot be eliminated as the absence of a Shariah adviser leads to Shariah non-compliance risk. Another great example is the world of DeFi (decentralized finance) applications that are designed to work via blockchain and smart contracts. They include monetary banking platforms, lending platforms and DEXs (decentralized exchanges) and so on. All of these platforms and applications are subject to Sharia compliance review. In fact, some of these platforms utilize riba (usury) which is forbidden from a Sharia perspective.

Considering all the related issues, instead of using “smart contract code”, the use of “smart legal contract” is deemed a better, or even compulsory option. One of those two terms refers to elements of a legal contract being represented and executed by software. The other one is the code designed to execute certain tasks. Every smart legal contract will contain some elements of a smart contract. However, not every smart contract will be a smart legal contract. Thus, in the previously given example, Ahmad and Aisha have the option to use smart contracts to memorialize a limited set of promises or details of their agreement as part of a larger, more complicated contractual relationship. This also illustrates the need for a Shariah adviser to be present at least in the first stages of the agreement.

In brief, even though Fintech is considered as a disruptive technology, it does not mean that Islamic Fintech can escape from the rulings. The disruptiveness happens in the technological advancement in doing the transaction, but not in its rules and principles. Smart contracts in Islamic Fintech should tie with Islamic values and the core principles of contractual relationship. This requires the continuous presence of Shariah advisors in all types of FinTech application, including smart contracts.

References

– Fintech and Shariah Principles in Smart Contract, Mohammed Hariri Bakri, et al.

– Sukuk on blockchain: a legal, regulatory and Shariah review, Sherin Kunhibava, et al.

– Introduction to Fintech and Smart Contracts, Ismail Dadabhoy.

– Fintech, Smart Contracts and Blockchain, Nicholas Edmondes et al.

– Fintech and Smart Contract: Opportunities in Islamic Finance, Mohamad Akram Laldin.

– Crypto Yield Farming, Mufti Faraz Adam.

– Blockchain and the Law, Primavera De Filippi and Aaron Wright.

https://en.wikipedia.org/wiki/Smart_contract

https://www.investopedia.com/terms/s/smart-contracts.asp

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