Bank of Israel Digital Shekel CBDC Trial Highlights Risk of Unsupervised Smart Contracts

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After nearly a year of extensive research into a digital shekel CBDC, Israel’s central bank believes smart contracts should be regulated by it.

After a two-phase trial of the digital shekel, the Bank of Israel concluded that coders of smart contracts could plant malicious code in the protocol that could lose users’ funds.

Seeing an opportunity to securely simplify payments in sovereign currencies, the bank participated in a digital shekel experiment. It found it crucial to understand who was writing the smart contracts responsible for processing transactions. Smart contracts are protocols written in code that allow the exchange of funds between parties and operate with a high degree of automation. While smart contracts are publicly visible in the Ethereum ecosystem, there is no guarantee that coding errors will not occur.

Researchers at the bank said today that allowing anyone to write these contracts would be too risky for the wider financial system. While the bank itself is unlikely to code smart contracts, it may delegate this responsibility to payment service providers (PSPs) and provide oversight.

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Test Results and Questions

The bank is conducting the trial in two phases, the first of which aims to build a cloud-based Ethereum blockchain platform, Quorum, to issue ERC20-compliant currencies and conduct basic transactions. The first phase also looked at the possibility of limiting the amount exchanged in transactions to prevent customers from withdrawing large amounts of funds and converting them into digital shekels, as well as using smart contracts to deliver funds to parties instead of traditional payments. Transactions are done using a proof-of-authority consensus mechanism.

The second phase of the trial focused on the privacy provided to participants in digital transactions. The findings are in line with an initial proposal from the Steering Committee for the Potential Issuance of Digital Shekels to limit the number of anonymous transactions a user can participate in, beyond which all details of participants will be recorded.

BOI emphasises not commitment to digital shekel

The Bank of Israel stressed that the trial in no way guarantees the issuance of a digital shekel. Instead, it is used to help its professionals understand distributed ledger technology and the underlying open source Ethereum ecosystem. Speaking of ethereum, Norway’s Norges Bank recently put out a tender for ethereum L2 solution Nahmii to create a sandbox for its CBDC experiments.

With growing public support, the Bank of Israel recently launched a joint CBDC project with the Hong Kong Monetary Authority. The project is scheduled to launch in the third quarter of 2022, and commercial banks will act as intermediaries between clients and the central bank. It will focus on hardening the currency against cyber attacks.

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