Imagine a financial system where you don’t have to rely on expensive and fallible third parties to manage your money. You have complete control of all your assets and you can easily send them to anyone anywhere. Well, imagine no more; decentralized finance (DeFi) exists so you can fully take charge of your financial assets. If you haven’t quite got your head around DeFi, this article will give you some clarity. We will also explore whether Islamic or halal DeFi on the blockchain is possible with halal crypto and decentralized applications.
What Is DeFi?
Decentralized finance (DeFi) is a blockchain-based technology that uses secure distributed ledgers to record financial transactions. DeFi platforms are built with a multi-layered architecture that facilitates direct exchanges between participants, eliminating the need for third-party mediators. This is done by programming self-executing smart contract codes to transfer and store digital assets.
History of DeFi
The term DeFi was first used in 2018 on a Telegram chat between Ethereum developers and early investors. Ethereum is a blockchain technology created by Vitalik Buterin as a decentralized ecosystem for building apps and transacting assets.
While the term DeFi has only surfaced in recent years, the concept has been around since the inception of Bitcoin in 2009 – a key enabler for the whole cryptocurrency industry.
However, Bitcoin did not have the capacity for a robust financial system. Its simple and limited programming language called Script did not allow for services such as lending, borrowing, and trading.
This limiting factor was one of the reasons that encouraged Buterin to build Ethereum in 2015.
With Solidity as its programming language, the Ethereum network is able to support a complex range of financial functions using smart contracts.
It was not until December 2017 with the launch of MakerDAO that DeFi truly started to kick off. This was followed by a stream of DeFi projects such as Compound Finance, Uniswap, and Balancer.
Every new platform rose as an improved version of Ethereum-based financial technology providing better opportunities to digital asset owners.
Key Characteristics of DeFi
DeFi is a network of protocols and applications that serve a new mode of financial management. It simplifies transactions and enhances the accessibility of investments by reaching a wider audience.
The following are the defining features of DeFi:
Decentralized
Traditional financial systems rely on centralized financial institutions such as banks and third-party intermediaries to facilitate transactions between people. On the other hand, DeFi is described as a “non-custodial” system. This means that DeFi apps do not have custody over your assets. You are in complete control of your crypto wallet and funds while benefiting from secure peer-to-peer transactions.
Open and transparent
DeFi uses a distributed database that records every transaction on the blockchain, which is verified by validators across the globe. Anyone can inspect and track the transactions but they would not be able to modify as transactions on the blockchain are immutable.
Interactive and composable
Blocks of transactions are stored on decentralized applications (DApps) that are built by developers using open-source codes. This enables the innovation of apps that can support complex financial services to suit the needs of niche communities. This feature, along with the inherent unchangeable nature of crypto-based ledgers provides a secure platform for digital assets.
Pros and Cons of DeFi
The DeFi system is constantly evolving to meet emerging challenges in the sphere of digital finance. The regulation-free nature of blockchain technology generates a unique combination of pros and cons for DeFi users.
Benefits of DeFi
1. Greater freedom and autonomy
The decentralized nature of DeFi allows users to maintain anonymity while engaging in financial activities around the world. Although the transaction is made in the public domain, decentralized exchanges (DEXs) remain non-custodial and free of middlemen. This allows users to have complete control over their digital funds.
2. Speed and simplicity
Financial ventures based on web3 are known for easy accessibility and hassle-free dealerships. Individuals can use specialized algorithms to match with a peer who can meet their needs in terms of asset borrowing, investment goals, and time scales. Players can then enter into private contracts where they can exchange assets via blockchain-supported DApps.
Popular cryptocurrency wallets such as MetaMask, Coinbase, and Sahal can be used to interact with multiple web3 financial DApps. This reduces the strict gatekeeping and delay that are typical of traditional financial institutions.
3. High security
DeFi utilizes cryptocurrencies to facilitate financial transactions through immutable smart contracts. This creates a high level of security and confidentiality in asset management. Furthermore, DEXs reduce the risk of theft from hacking or price manipulation by maintaining an encrypted history of all financial movements on its platform.
Disadvantages of DeFi
1. Risk of fraud and scams
With the rising number of DeFi projects competing for market share, consumers may find it difficult to locate trustworthy platforms for investment. Since DeFi projects do not take responsibility for verifying user legitimacy, there is an opportunity for cybercriminals to employ crypto trading for illegal activities.
2. Volatility
As an emerging asset class, cryptocurrency is still volatile. This means that the price of crypto assets can show significant upward or downward movement over a short period. As crypto assets are used within DeFi, this may be a cause of concern for users.
To reduce volatility-related concerns, stablecoins were developed in an attempt to peg their market value to non-cryptocurrency-based assets. Stable assets such as gold or the US Dollar are commonly used as valuation references for Stablecoin.
Can Halal DeFi Be Created?
Islamic Finance refers to a set of business and investment practices that deal with money according to Islamic principles.
The key tenets of Islamic Finance include:
- Socially responsible and ethical investments i.e., investing in activities such as alcohol, gambling, and others are forbidden.
- Avoidance of riba (usury) and gharar (deception) in financial activities.
- Prohibition of lending with an interest payment at the borrower’s expense.
As to the question of DeFi’s compatibility with Islamic law, a conscious individual must investigate whether a DeFi project complies with Islamic principles.
The crypto tokens used in the project as well as the project mechanism must be free of exploitative lending schemes to be considered Halal or permissible for investment. As such, a halal DeFi project would need to use halal crypto tokens for value exchange.
Halal DeFi: Integrating Islamic Finance to DeFi
To facilitate ethically-sound investment in the web3 space, MRHB has built the world’s first halal DeFi ecosystem. The aim is to enhance financial inclusion for the faith-based community and provide support for wealth creation and preservation. Each cryptocurrency and protocol is vetted through a smart contract “filter” as well as the Shariah Governance Board.
The gateway to halal crypto awaits you; download the Sahal Wallet app for easy access.