The Bank of Israel has begun trials in issuing the digital shekel, thus joining most of the world's central banks that have also been conducting trials on digital currencies. Beyond the fact that a digital shekel sounds very innovative, why are central banks involved at all in issuing digital currencies and how will it all work?
How does a digital currency work
A digital currency in effect turns the promise represented by the shekel, or any other sovereign currency, into a direct promise from the central bank. For example, the value of the shekel is currently set by the level of commitments by the Bank of Israel but when conducting currency transactions and transferring money, the customer conducts these with money in the commercial banks with whom they work. This is the case in transferring money from account to account, or from one bank to another, and the commitment in the process is by the commercial banks. But when there will be a digital currency, the transfer from one place to another will take place without mediators.
Does that mean we can dispense with the banks?
There are two possible models for working with digital currencies.
In the first model the end customer would open an account at the central bank, in our case the Bank of Israel, and work through there.
In the second model, the Bank of Israel would issue the digital currency, with the activities of the end customers conducted through a range of financial service providers, for example banks and the spectrum of fintech companies that offer financial services, and it will be possible to choose to work with either the banks of the fintech companies. This is the more popular model worldwide and it is also the model chosen by the Bank of Israel, for the simple reason that it is not interested in providing services to end customers.
Then what is the difference between this model and the existing model?
Those holding the digital shekel won't need to have a bank account. They can hold the shekel in a digital wallet and then have two options: to work with an identified account in the bank or transfer it through the code of the currency - this allows the holder privacy in conducting purchases: on the blockchain network every buyer is registered. If they operate through an account, the buyer is identified, whereas through the code the currency keeps its privacy. In the models that have been examined, transfers using a currency code can only be conducted up to a certain amount, and above that only via a recognized account. Privacy is maintained only through use of cash but with a digital currency, every small purchase will be recorded.
Are there any countries that have already issued digital currency?
The Bahamas has issued a digital currency. The rationale is the many hurricanes that hit the region and the large geographical spread of the islands creates a situation requiring immediate payments to far flung locations. In the Bahamas, the digital currency is managed at two levels: through an account that has passed a "know the customer" procedure, and with a currency code for small amounts.
Among developed countries, a trial will be carried out during the Winter Olympics in China in February 2022, when there will trials using various payments system and in the digital yuan.
In addition to cash, not instead of
Why do we even need this?
"The benefits that the central banks around the world see in issuing digital currencies vary from country to country, and the design and characteristics of this digital currency, will be according to the aims of the issue," explained Herzog Fox Neeman banking and finance department partner Adv. Dr. Esti Hadar. "The Bank for International Settlements (BIS) together with seven leading central banks (US, Euro bloc, Japan, England, Canada, Sweden and Switzerland) published several reports in September 2021 presenting some of the findings of the work they have carried out to examine the issue, and as part of this they presented some of the reasons for central banks to issue digital currency including keeping secure access for the public to the central bank's money in a digital economy and an instrument for maintaining financial stability in a changing reality. In the report, published by the Bank of Israel in May 2021, it made clear that like other countries worldwide that as long as it issues the digital shekel it will be in addition to cash and not instead of it.
"In this report the Bank of Israel presented six main reasons for issuing the digital shekel. The first is the creation of an efficient, advanced and secure alternative to the existing and new means of payment in the digital era. The second benefit is the creation of a payments infrastructure that will support the innovative adoption and adapt the payments system to the needs of the digital economy. The third benefit is to secure the balances of the payments system and its proper functioning during an emergency or breakdown. The fourth benefit is the creation of an efficient and cheap infrastructure for cross-border payments. The fifth benefit is to provide the public with the possibility of making use of digital means of payment, while keeping a certain level of privacy. And the sixth and final benefit is to support government policy in reducing use of cash and combatting the 'black economy.'
How will money be transferred internationally?
"This is one of the main issues being examined as part of the joint BIS project and in several countries worldwide including China. Various options are being examined for application but no model or process has yet to be formed," Adv. Hadar said.
What are the concerns of central banks around the world?
The banks are concerned about "stable coin" currencies and mainly the currencies of giant organizations like Facebook. Organizations like these for whom we are not the customer but rather the product, and who also have a lot of information about us, can create end-to-end payment systems with broad influence on the economy.
What worries the banking system?
The main concern is that there won't be deposits of digital shekels in banks but the currency will be kept in a wallet or transferred to other bodies that provide financial services. The deposits are the source for banks to extend credit and without them there could be a credit crunch.
Prior to the order prohibiting money laundering coming into effect in Israel, the two big banks formulated a position on how it would be possible for them to receive money made from cryptocurrency profits. In addition to all the requirements of the order about the source of the money and the path that the money had passed through, the big banks adopted a practice that required approval from the investor's accountant or lawyer, before the money could be deposited in the bank.
Bank Hapoalim demands the signature of "an expert in cryptocurrency matters" on a special form that the bank provides. The definition of an expert includes a lawyer, accountant and organizations specializing in regulation of financial currencies. At the top of the form, the experts must declare their expertise and that they are familiar with the instructions of the bank. After that they must provide confirmation that the source of the money is from the sale of virtual assets that were sold and purchased from the customer's same address and that the address of the wallet does not have any other transfers from other sources, except for the customer, and if there were other transfers then that they were conducted by a supervised body and that the purchase and the sale were conducted by a body under the supervision of the Bank of Israel, or a foreign state whose money laundering authority complies with acceptable international standards.
To follow the path of the money
Bank Leumi does not have a set form for the signature of an expert but requires confirmation from an accountant who confirms that the currencies were purchased and sold from the same electronic wallet and that there were no other transactions from that address. The accountant must also detail all transactions including amounts, dates and with whom the transactions were conducted. Finally the accountant must declare that the transaction was properly conducted from a tax point of view.
These confirmations and approvals from experts are part of a wide range of checks and documents required by the bank in order to track the path of the money.
Published by Globes, Israel business news - en.globes.co.il - on October 29, 2021.
© Copyright of Globes Publisher Itonut (1983) Ltd., 2021.