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

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After extensive digital shekel CBDC research lasting almost a year, Israel’s central bank believes that smart contracts should fall under its supervision.

After a two-stage digital shekel trial, the Bank of Israel concluded that coders of smart contracts could seed the agreements with malicious code, losing users’ money.

Seeing the opportunity to simplify sovereign currency payments securely, the bank participated in a digital shekel trial. It found that it is critical to know who is coding the smart contracts responsible for processing transactions. Smart contracts are agreements written in code that allow the exchange of funds between parties and operate highly automatedly. While in the Ethereum ecosystem, smart contracts are publicly visible, this does not guarantee the absence of coding mistakes.

Allowing anyone to write these contracts is too great a risk to the broader financial system, the bank’s researchers said today. And while it is unlikely that the bank itself will code the smart contracts, it may delegate this responsibility to payment service providers (PSPs) and provide supervision.

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Trial results and issues

The bank conducted the trial in two stages, with the goals of the first stage to establish a cloud-based Ethereum blockchain platform, Quorum, issue the ERC20-compliant currency, and conduct rudimentary transactions. The first stage also investigated the possibility of limiting the amount exchanged in the transaction o prevent customers from withdrawing large amounts of money and converting it into digital shekels and the use of smart contracts for delivering money to parties instead of traditional payments. Transactions were finalized using a proof-of-authority consensus mechanism.

The second stage of the trial focused on the privacy afforded to participants in a digital transaction. The findings corresponded with an initial proposal by the Steering Committee for the Potential Issuance of a Digital Shekel that limited the number of anonymous transactions a user could participate in, beyond which all details of participants would be recorded.

Not a commitment to a digital shekel, BOI emphasizes

The Bank of Israel emphasizes that this trial in no way guarantees the issuance of a digital shekel. Instead, it was used to help its professionals understand distributed ledger technology and the underlying open-source Ethereum ecosystem. Speaking of Ethereum, Norway’s Norges Bank recently awarded a tender to Nahmii, an Ethereum L2 solution, to create a sandbox for its CBDC experiment.

The Bank of Israel recently embarked on a joint CBDC project with the Hong Kong Monetary Authority amid growing public support. The project, slated for launch in the third quarter of 2022, will see commercial banks used as intermediaries between customers and central banks. It will focus on hardening the currency against cyber attacks.

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