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Bank of Israel gets its hands dirty with digital currency

So far, no country has a digital currency issued by its central bank (CBDC) but some are actively examining the possibility.

As revealed by “Globes”, the Bank of Israel too is at that stage, and is examining the Etherium system.

Nevertheless, the bank is a long way from choosing the technology on the basis of which the digital shekel will be issued, if indeed it happens at all.

“We did a trial with Etherium technology, not because we think that that’s necessarily the technology we’ll use, but because it was a technology that was available for us to get our hands dirty with, in order to understand its advantages and disadvantages,” said Yoav Soffer, CBDC project manager at the Bank of Israel, following the report by “Globes” of the trial that the bank was carrying out. Soffer made his remarks at the central bank’s digital currency conference – Innovation, Opportunities and Challenges – held last week.

In the Bank of Israel’s pilot program, teams from its IT division set up a trial environment based on Etherium blockchain. The bank issued a token representing digital shekels, and digital wallets were set up from which project team members could transfer “imaginary digital shekels” from one to another within the bank. It is not a case of real money, but of a trial environment only. Etherium is being used on a closed network, unconnected in any way to the general Etherium network or to the cryptographic currency ether.

The same technology has been used in trial projects carried out at the central banks of Australia, Hong Kong, and Thailand. In its pilot program, the Bank of Israel examined economic, legal, and technological aspects of a CBDC.

“It’s rather challenging to run a project like this. In general, projects at the Bank of Israel have start and finish dates. You know when they will end and what you need to achieve along the way. We don’t know when this project will end, with all that that implies,” Soffer said at last week’s conference.

Soffer said that the prevailing model among central banks today took into account that the bank would issue the digital currency and that access to it would be through payments providers (not only banks, but also technology companies, or certain non-profit organizations). The Bank of Israel is trying to come up with a model in which the payment providers do not touch the money, unlike credit card companies, which hold the money themselves.

The challenges: Infrastructure and usage habits

Digital payment methods have been growing in Israel, and all the more so during the COVID-19 pandemic, and the need to examine the issue of a digital shekel arises from this. Two of the most substantial challenges that the Bank of Israel faces are connected to infrastructure and people’s habits in using payment methods. The question arises whether it is possible to construct a digital shekel system that will provide for all the needs imaginable, considering that the idea is to produce a simple payment method that everyone can use that at the same time is also advanced and innovative. The greater challenge is more long term. The Bank of Israel is pondering the question how, from what we know today, can an infrastructure be constructed for the payments world of 100 years from now.

As we know, central banks and government bodies are not strong on innovation. The private sector has been asked to participate in the project, and the Bank of Israel’s door is open to entrepreneurs from all over the world to examine the possibility of payments ventures in Israel. In the past few years, the payments applications market has expanded, and the Bank of Israel’s innovation department is working simultaneously on a digital check and other payment methods.

The motivation: Competition and innovation

Adopting the digital shekel involves several risks that go beyond providing a local digital payment solution. The main risk is harm to financial mediation: if the Bank of Israel does the job too well and the public flocks to it and empties out the commercial banks, for example, or risks to the monetary system and the central bank’s reputation if the move is not executed properly. Because of this, the steering committee compiled a list of justifications for the issue of a digital currency.

The first concerns competition. Today, most transactions are carried out digitally, and the question arises how to stay competitive against other payment methods. Payment by cash is simple and cheap, and so it represents competitive pressure on other payment methods. The Bank of Israel is considering how to preserve competitiveness in the digital dimension. There must not be hitches that send users back to using cash. On the other hand, it’s hard to outline the competition that the future payment system will face, so that it is still not clear how to generate competition in a world in which the consequences for the financial systems and the payments system of the issue of a digital shekel are still unknown.

Another justification for issuing a digital shekel is innovation – building an infrastructure for a payments system that will be appropriate for an expanding digital economy. Questions arise such as the role of the public sector in creating the infrastructure for technological applications, and whether this means that blockchain should be used, or perhaps other technologies. How can a payments system be secured at a time of emergency or a breakdown, such as the one that took down Facebook’s services for seven hours, or a local failure, such as a power outage? The Bank of Israel is even examining the worthwhileness of setting up a separate payments infrastructure that will work offline.

The Bank of Israel presents international payments as a further motivation . The aim is to produce an efficient, cheap infrastructure for cross-border payments. On that, questions arise such as which foreigners can hold digital shekels, and how? For tourism it should be simple, but how do Israelis make payments overseas, or convert currencies, and how is it possible digitally to imitate the physical transfer of currency with as few intermediaries as possible along the way?

The balance: Privacy versus efficiency

Perhaps the most substantial question is that of the privacy of the ordinary individual vis-a-vis the state, the Bank of Israel, or the intermediary. One of the Bank of Israel’s challenges is to make people who use cash switch to digital payments. For better or worse, the use of cash in anonymous, and everyone has the right to buy a product without commercial concerns using his or her payments data.

Issuing a digital shekel could make consumers’ lives better through discounts deriving from consumption habits, which can be monitored, but precisely that is what threatens privacy. The Bank of Israel is asking whether it is right to leave the public with the choice between privacy models. This is a deep moral and social question, on which it’s hard to see how privacy advocates can be kept happy, and how the need for making digital payments can be met while preserving the properties of using cash, while at the same time preventing tax evasion.

Source: Globes