With the rise of blockchain solutions and blockchain adoption, Islamic financial institutions are increasingly looking into deploying blockchain into their operations and underlying workflows. Similarly, crypto-projects are being launched with several underlying structures and types of token issuances. Most of the crypto-projects are based on public blockchains and hence need consensus mechanisms. Private blockchains – which are more commonly adopted by businesses and financial institutions – have different requirements compared to public blockchain networks and therefore need alternative consensus algorithm and technical trade-offs. In private blockchains, more emphasis is put on transaction throughput, fault tolerance, overall efficiency and restriction of access to the blockchain data and smart contracts.
Consensus algorithms are a decision-making process for a group. These blockchain consensus models consist of some particular objectives, such as, coming to an agreement by nodes, collaboration, cooperation, giving participants equal rights, facilitating participation and most importantly, facilitating agreement on validating a block to be appended to the chain. One of the most common consensus protocols for blockchains is Proof-of-Work (PoW). PoW is the first blockchain algorithm to be introduced. Many blockchain technologies uses this blockchain consensus model to confirm all of their transactions and produce relevant blocks to the network chain. To manage the data, the individual nodes are called miners and the process they use to maintain it is called mining. A node is a powerful computer that runs the bitcoin software and fully validates transactions and blocks. The central principle behind this technology is to solve complex mathematical problems and easily give out solutions.
PoW works by miners solving cryptographic puzzles to “mine” a block in order to add to the blockchain. This process requires immense amount of energy and computational usage. The puzzles have been designed in a way which makes it hard and taxing on the system. When a miner solves the puzzle, they present their block to the network for verification. Verifying whether the block belongs to the chain or not is an extremely simple process. New blocks come with a hash function, and each of them contains the hash function of the previous block. By this way, the network adds an extra layer of protection and prevents any type of violations. Once a miner solves the puzzle, a new block gets created, and the transaction is confirmed. The minor is rewarded for this service with a newly created crypto-asset and transaction fees.
Any block that includes an invalid transaction will automatically be rejected by the network. It’s expensive for you to even attempt to cheat. You’ll waste your own resources without any reward. Therein lies the beauty of Proof of Work: it makes it expensive to cheat, but profitable to act honestly. Any rational miner will be seeking ROI, so they can be expected to behave in a way that guarantees revenue.
Miners in essence receive two rewards:
1. Block rewards which are a fixed number of crypto-assets form the network protocol.
2. Transaction fee which is paid by the users of the crypto-asset.
When considering PoW from a Shariah perspective, a Ju’alah structure is the most reasonable. Ju’alah is a contract in which one of the parties (the Ja’il) offers specified compensation (the Ju’l) to anyone (the ’Amil) who will achieve a determined result in a known or unknown period. In the PoW, the network protocol offers minors new crypto-assets as a reward for mining.
Ju’alah’s permissibility is based on a known output whilst the input can be left uncertain. It is not affected by the uncertainty that prevails with respect to the subject-matter of the contract, that is, the work to be done. It is for this reason that Ju’alah is suitable for activities for which Ijarah (leasing), which requires that the desired work be clearly specified, is not. Further, a Ju’alah does not need to be contracted with any specific individual. A Ju’alah contract can be concluded by an offer directed towards a specified worker or towards the general public. As such, in a blockchain network, the offer is addressed to all the nodes in the network.
The subject matter of the contract is the work that is agreed upon through Ju’alah as well as the compensation for the work. In PoW-based consensus protocols, the network decides on the compensation. Therefore, it is known in advance.
To consider the PoW as an Ijarah is somewhat deficient and inaccurate; an Ijarah is contracted with a specific person or group of people (a company) to deliver specific services in a defined timeframe. The uncertainty in the mining process in respect to which node will solve the puzzle creates an issue for Ijarah contracts. Ijarah requires all those contracted under Ijarah to receive a fee for the work they deliver. If PoW was an Ijarah, it would mean many who have worked to solve the puzzle will not be compensated for their effort and time. This is not Shariah compliant. On the other hand, Ju’alah allows for this uncertainty and the reward is not in lieu of a person’s services per se, but the fulfilment of an outcome. Further, Ijarah requires some awareness of who the counterparty. Ju’alah has no such requirement. However, it can be said that in a network, your identity is your public key and that is your ‘name’ so to speak.
Miners are also rewarded by transaction fees paid by the sender of the crypto-asset. This is simply a commission and a brokerage fee which can be considered as a Wakalah fee or even another Ju’alah from the sender of the cryptocurrency. Although the above analysis is purely of the underlying mechanism, the service of the blockchain and the transactions that are being validated must be Shariah compliant too for a particular blockchain to be classed as Shariah compliant.
The beauty in all of the above is that Shariah is applicable in every sphere, no matter how advanced the technology. There is always guidance from the Shariah for every era and for every development.