Application of a distributed verification in Islamic microfinance institutions: a sustainable model

Abstract

The literature gap in microfinance paradox of double bottom line (financial performance vs. outreach) has always been an interesting area of research. This paper proposes a theoretical model most suitable for Islamic Microfinance Institutions (MFIs) which enables Islamic MFIs’ to operate together with the existing financial models compliant with Islamic Shariah Law. This model is based on a distributed verification/decision-making process that might be realized (but not necessary) through blockchain. Among the available distributed verification techniques, blockchain technology is an attractive emerging computing paradigm due to its decentralized, immutable, shared, and secure data structure characteristics. This model proposes three significant propositions. First, sharing information through blockchain will allow a transparent network in MFI operations, which will raise confidence for donors resulting in a causal effect of a relatively lower profit rate to be charged by the MFIs. Second, the consensus mechanism will enable risk-sharing, a character of Islamic finance; thus, the MFIs will operate without any collateral for low-risk firms. Third, the double bottom line of MFIs' long-lasting paradox would be solved. As for practical implication of this proposed model, the causal impact of lower cost investment by the lenders would increase social welfare because of no collateral and no initial wealth requirement. The proposed model proposes a credit rationing approach where profit can be negative. No collateral will be used when calculating the creditworthiness of a borrower.