February 24, 2023
The Mudharabah Principle
Mudharabah is a term used in Islamic finance, which refers to a business contract in which an investor (rab ul-maal) provides capital to a manager (mudarib) to carry out a particular business venture. The profits generated from the venture are shared between the two parties based on an agreed-upon ratio. This principle provides a better incentive for exchanges than interest, for several reasons.
Centralized Exchanges (CEX) ushered in a new era of easy access to cryptocurrency trading. Third parties made exchanges user-friendly and simple to understand. As a result of the widespread adoption, cryptocurrency trading has exploded. However, this came at a cost.
For starters, the Mudharabah principle encourages risk sharing between the investor and manager. In traditional interest-based systems, the lender bears no risk, while the borrower bears all risk. This creates a moral hazard problem, in which the borrower may take an excessive amount of risk knowing that no loss will be borne by the lender. In the Mudharabah system, on the other hand, the investor and the manager share the venture's profits and losses, which encourages the manager to make more prudent investment decisions, thereby reducing the moral hazard problem.
Furthermore, unlike traditional interest-based systems, the Mudharabah principle is more equitable. In traditional systems, the lender receives a fixed rate of interest regardless of the success or failure of the borrower's investment. This is potentially unfair to the borrower, who may be unable to generate enough profits to cover the interest payments. In the Mudharabah system, profits are split between the investor and the manager based on an agreed-upon ratio. This means that the investor is only entitled to a portion of the profits if the venture is a success, which motivates the manager to work harder in order to generate profits.
Additionally, the Mudharabah principle is more conducive to long-term relationships between investors and managers. In conventional interest-based systems, the lender is only interested in receiving a fixed rate of interest, regardless of whether the borrower continues to be successful or not. This creates a short-term focus, where the lender may withdraw their investment if the borrower experiences any difficulties. In contrast, the Mudharabah system promotes a long-term focus, as the investor and the manager share the profits and losses of the venture. This encourages the manager to build a successful business over the long term, which benefits both parties.
Biokript, the world's first hybrid shariah-compliant crypto exchange, is an excellent example of how the Mudharabah principle can be applied to modern finance. Biokript uses the Mudharabah principle in its profit-sharing incentives, offering BKPT token holders a share of the profits generated by the platform. This promotes a fair and equitable system for all users.
With Biokript, investors can enjoy the benefits of a shariah-compliant platform, which promotes risk-sharing and is consistent with Islamic values of fairness and social responsibility. Furthermore, the profit-sharing incentives encourage a long-term focus, as investors are motivated to see the platform succeed over time. As the world becomes more aware of the benefits of ethical investment, the Mudharabah system may become more widely adopted by both Muslims and non-Muslims alike.