The Bank of Israel has concluded a cross-border currency payment platform project together with other central banks as it evaluates the potential issuance of a digital shekel.
As part of the project dubbed Icebreaker, the Bank of Israel, together with the central banks of Norway and Sweden and the Bank for International Settlements (BIS) Innovation Hub, examined the potential benefits and challenges of using so-called retail central bank digital currencies (CBDC) in international payments to create a hub to interlink domestic systems across borders.
As digitalization in the global financial system develops rapidly, the Bank of Israel has over the past few years started preparations for an eventual launch of a digital currency, to have a plan ready if conditions develop that lead the central bank to believe that the benefits of such a currency outweigh the costs and potential risks.
The Bank of Israel’s CBDC project manager Yoav Soffer noted, “Early on in our work on the digital shekel we wrote: ‘As part of the G20 roadmap for improvement of cross-border payments… the ability of CBDCs to streamline and lower the costs of these payments will be examined…. If such a global infrastructure is actually developed, a Bank of Israel digital currency will improve cross-border payments for Israelis.'”
“Well, today we are one step further towards this goal,” Soffer, wrote in a LinkedIn post.
Central banks around the world are pondering whether in the near or distant future they will have to provide the public with another form of currency — digital money – as cross-border payments still face challenges such as high costs, low speed, limited access and insufficient transparency.
Digital money already exists, in a way: the money the public holds in banks, which it pays from via bank transfers, payment cards and payment apps. The retail CBDC that is being considered now would give households and businesses access to use the Bank of Israel’s digital money in addition to physical cash. This would constitute a liability of the central bank toward the holder of the currency, as opposed to a liability of a commercial bank toward the user of the currency as is the case with payments today.
“If Israel is to issue a digital shekel, it would be very important that we do it according to the evolving global standards, so that Israelis could use it also for efficient and accessible cross-border payments,” stated Bank of Israel deputy governor Andrew Abir. “While there is still much work ahead of us for the Icebreaker model to become a global standard, the learnings from this successful project have been very important for us and for the central banking community.”
The Icebreaker project tested the “technical feasibility of conducting cross-border and cross-currency transactions between different experimental retail CBDC systems,” the participating central banks said in a joint statement. The model provides a marketplace for cross-border payments by interconnecting retail CBDC systems facilitated by a foreign exchange provider active in both domestic systems.
For example, if Alice in Sweden wanted to pay Bob in Israel, the FX provider would buy Swedish krona and sell Israeli shekel, in one of the examples cited in the research project. In practice, they would buy one currency in one retail CBDC system, paying with the other currency in the second system.
“In most existing cross-border payment systems, the payer has no choice regarding the exchange rate, as it has no control on who the provider of foreign exchange conversion is,” according to the findings of the research project. “In the model developed by the Icebreaker project, many foreign exchange providers can submit quotes to the system’s hub, which automatically selects the cheaper one for the end user.”
While cryptocurrencies do not belong to any specific country and some have no central authority to manage them, a CBDC will be issued by the country’s central bank, and it is the central bank that would determine its quantity, its manner of use, and the regulations that will apply to it.
For the digital shekel, the Bank of Israel envisages a two-tier approach in which a partnership is set up for the creation of the CBDC between the central bank and the private sector (banks, credit card companies, and technology and/or finance companies from Israel and abroad). With this partnership, the central bank will provide its digital currency not directly to the public but rather via the private-sector institutions.
“One of the major lessons is that combining the riskless nature of CBDCs with the advanced technologies which will build them could have endless potential in improving the payment scenarios we are all familiar with as well as creating a universe of new transactions that would support new economic activities,” Soffer remarked. “In Icebreaker we had set the foundations by simulating manual and relatively simple transactions, but the model we created sets the ground for highly advanced cross-border micropayments and conditional payments, between end users in different parts of the globe.”
“Lots of work is still needed to make this real, and [there are] many aspects we did not touch upon,” he noted.