Sharia-compliant debt crowdfunding: Aligning fintech with Islamic finance

Companies around the world are using a new–age collaborative means to seek funds from investors, both big and small. They do this around the world. One innovative approach is the Sharia-compliant debt crowdfunding platform, known as crowdfunding. It is a powerful way to seek debt or share investments from investors, allowing them to get a return on a project or business. 

As more and more crowdfunding networks surge, there is a new revolution among companies these days to become Sharia-compliant to seek the trust of Islamic investors for a better social impact. 

In this blog, we are going to study in detail Sharia-compliant debt crowdfunding methods.

Sharia-compliant crowdfunding- The basic idea

Sharia crowdfunding is generally a subset, a type of crowdfunding using online platforms to seek funding opportunities for various projects, business expansions, and even startup ideas. 

The basic idea it uses is based on the bottom-up structure of microfinance principles. The idea is to come up with a social change and get rid of any traditional financial issues. 

In Islamic finance, it is compliant with a set of guidelines set by the Sharia principles under Islamic religious rules. The crowdfunding software using it uses advanced fintech models and technologies to fund projects and get rid of traditional financing methods. 

Islamic Finance and Crowdfunding 

Islamic finance through crowdfunding is making use of decentralised finance, also known as Islamic Decentralised Financing or simply Islamic DeFi, to come up with ethical and transparent ways to fund business projects and startup ideas under the laws of Islamic finance. 

There is a difference you need to understand in Islamic financing and crowdfunding methods. While most funding methods involve interest, the Sharia laws state otherwise and deem getting interest through funding as a form of sin, as per their religious beliefs. 

The debt crowdfunding software is built using Sharia laws. Thus, it eliminates any form of interest transactions. It also helps to get rid of any form of uncertainty and speculative gains from financial activities.  

Crowdfunding portals built using decentralised financing models have some significant technological advancements in the fintech sector. Just to give you an idea, it makes use of blockchain to get rid of any intermediaries. This helps entities get access to funds or any other financial services. 

The Islamic financing model that you get on most crowdfunding software these days uses risk-sharing methods of funding, which are often backed by an asset to reduce the chances of any default in payments. The use of high-end technology like blockchain and decentralised servers also ensures justice and parity in transactions. 

The core principles under Sharia Law and compliance for crowdfunding 

In the Islamic religion, there is a strict and ethical framework that gives fairness and the right to equality for all. It avoids any form of financial exploitation. This is done through a set of practices as given below-

Prohibits Riba or interest

The Sharia laws, as we have told you above, strictly prohibit any form of interest through any investment or debt. It is considered a form of financial exploitation and is unjust when the lender seems to have an upper hand. 

Avoiding Ghahar or uncertainty

If you have to build an Islamic crowdinvesting platform, it is important to avoid ghahar or uncertainty in your transactions. It has to come out to the public clearly, stating the amount and other details of every transaction with timestamps on it. 

Each transaction that occurs in your platform has to be transparent between the two parties. This is basically to avoid any form of future uncertainty and reduce the risk of conflicts between parties.

Exclusion of Maysir or debt and investment for gambling and speculative trading

Any form of investment or giving debt for a speculative activity like trading, derivatives, gambling, or betting is prohibited. You cannot build crowdfunding software that invests in any of these sectors, as these are purely prohibited under the Sharia laws.  

Building a crowdfunding software using blockchain that is Sharia-compliant

There is a surprising similarity between the most advanced fintech model using blockchain and the Sharia laws. The basic pillars that seem to be the same in both models are based on transparency and immutability. They also have a decentralised nature to reduce risks. 

Here is how you can build a crowdfunding platform using blockchain that is compliant with Sharia laws  and Islamic DeFi-

Use of smart contracts 

Smart contracts can allow financial agreements to be executed automatically when it is fed into the programming code. The blockchain can automate such agreements that involve tangible assets and comply with the rules given under Sharia laws. 

Transparency and regular audits of transactions

Blockchain records and transactions are permanent and can be made accessible to the public for verification at any time. If you incorporate it into your crowdfunding software, people can come to your website and check for historical financial records. They can check their authenticity at any time. This is without any risk of online theft, sharing, or risk of privacy in financial transactions. 

Make use of a decentralized model to reduce risks

Decentralization offers a considerable reduction in the risk of data storage. An Islamic DeFi crowdfunding model will also allocate risks equally among all participants in an investment. This avoids over-exploitation of any party.

Smart contracts and Sharia-compliant lending

One of the major differences, as we have already told you above, when designing an Islamic crowdfunding model using blockchain is to avoid the integration of riba or interest in invested money. Here are some of the other models to look at without integrating interest-

Murabaha-based lending or cost-plus financing

Under the Sharia laws, you cannot garner interest through your investments. Rather, you can make use of Murahaba contracts. In this model, the lender will purchase an asset and sell it to the borrower at a pre-determined price at the time of the contract.

Here, the role of blockchain comes in handy. When programmed, it can easily execute the Murhaba contract. This contract contains details of the pre-agreed price, data, and time of settlement. This ensures transparency and also saves time to execute the process, saving time for both parties. 

Mudarabah-based lending or profit sharing

You can also build crowdfunding software with the use of Mudarabah-based lending. Here, there are two parties: one lends the capital and the other lends only their expertise. 

In the case of profits, they are shared using a pre-agreed-upon ratio. In the case of a loss, it is only borne by the party coming up with the investment money. When this is embedded in a smart contract, it will get executed on a specific date and time. This is as per the agreed ratio. It also ensures parity and safety for investors and gives proper profit sharing to each party. 

Ijarah or Islamic leasing

This is a form of leasing model for getting access to any resource, like land, property, and so on. Here, the lessee will pay the rental fees or the lease money as per the agreed terms, yearly, quarterly, or monthly, and use the asset for their business. Once the lease terms are over, the lessee returns the asset to its original owner. 

Here, the use of blockchain and smart contracts can help make the process of leasing and regulated transactions easier. It also makes them verifiable at any time using decentralized servers. 

Tokenization of assets in Sharia crowdfunding models

There is a unique way of tokenizing assets when it comes to Sharia compliance. Using Islamic laws where only tangible assets can be marked and ready for tokenization it can be used with blockchain in different business areas. These include properties, other commodities, and even businesses. 

As the tokens are backed by a physical asset, the owner of the tokens can never engage in speculative trading or gambling. Thus, they cannot get interest or more value than the original transaction amount. Plus, this model also ensures liquidity as per the loan-based crowdfunding regulations mentioned under Islamic laws.

Challenges and future areas of development

Even though the current methods used under blockchain and smart contracts are built in crowdfunding platforms, there is still room for challenges and future scope for development. 

One of the major challenges is in terms of changing Sharia laws under different subsets of the religion. A more permanent Sharia law can help in the development of a crowdfunding platform more easily. 

Along with this, the Sharia laws need to be approved by more financial regulatory bodies across the world for people to get access to them, which is still less in use. 

Last but not least is the complexity of building blockchain and smart contracts that are embedded with Sharia laws. It involves a lot of coding complexity, for which hiring designers and developers is still a major challenge. 

FAQs

How to make a crowdfunding platform Sharia-compliant?

As we have told you above, you need to refrain from interest through your debt or investment, avoid uncertainty, and exclude building a portal for speculative trading or gambling. 

How do smart contracts ensure easier settlement under Sharia laws?

Using any Sharia laws, you just have to program and build a smart contract and feed it into a blockchain, which is just a one-time process. Each time the smart contract is executed to process the transaction, with little fuss. 

How do you fetch returns for the investors in Sharia-compliant crowdfunding schemes?

You can make use of markup cost-up financing, lease financing models to get a good and steady flow of return for the investors.