By Ari Rabinovitch and Tova Cohen
RAMAT GAN, Israel (Reuters) - Israel's diamond exchange is turning to digital currencies to inject new life into a marketplace long ruled by cash and backroom handshakes, but it must first persuade traditionally conservative players that the technology can work.
One of the world's largest diamond centers, the exchange hopes its virtual currency will make trading more efficient and less opaque.
Current transactions are "often carried out anonymously, with the shake of a hand and minimal documentation", according to a recent report by Israel's Justice Ministry. That murkiness has led the FBI and Europol to target the trade as a vehicle for money laundering and crime financing.
Narrow profit margins between rough and polished gems make it hard for polishers to get financing, and banks have cut back lending or pulled out entirely.
Backers of the digital currency program believe it will help address those issues.
"We foresee alignment behind this currency because it's going to make things easy," Eli Avidar, managing director of the exchange, told Reuters in an interview.
"This industry is facing challenges, and this is going to in a lot of aspects address those challenges ... the profitability element of the business, the speed of doing business, money laundering aspects and the problematic elements of banking nowadays," he said.
The exchange is planning to launch two coins.
The first, to be known as the Cut, will be available only to dealers on a peer-to-peer basis. Traders from around the world will receive digital wallets after being vetted by the exchange, similar to today's background checks.
Each transaction will be verified in a matter of minutes and be available to the public on blockchain - a digital ledger maintained by a random group of peers - but the identity of who owns what will be kept private. The exchange can provide that information to regulators upon official request.
The Cut could solve increasing problems moving money between traders and retailers, one mid-size diamond dealer said.
"Transfers of money have become increasingly difficult. With banking regulation, even the smallest move becomes complicated. It can take days," said the dealer, who asked not to be identified because of the sensitivity of the process.
"Buyers don't want to give the money till they get the stone, and sellers don't want to give the stone till they get the money."
He wanted to see how it will be regulated, however, which may take some time, given that the coins are being launched without any government regulation in place, as is typical in the cryptocurrency world.
Bitcoin, the original cryptocurrency, has lost 70 percent of its value from its peak in December partly because of market concerns about a global regulatory clampdown. Many bitcoin backers say regulation should be welcomed.
A spokeswoman for the Economy Ministry, which oversees the diamond trade, says there has been no in-depth discussion yet on how the coins would be regulated.
Presale of the Cut went live at the International Diamond Week that started on Monday. The coins should enter into use within a few weeks, said Avishai Shoushan, CEO of the year-old CARATS.IO, which created the coins for the exchange.
The coin is based on an index using 14 parameters, compared with just four characteristics used to price physical diamonds.
Price is determined by an algorithm, because whereas gold is priced by the ounce or oil by the barrel, for example, diamonds are priced individually since each diamond is so different from the next.
A second coin, Carat, will be issued later and is meant for institutional and retail investors who want to invest in the diamond market without taking possession of physical diamonds.
"We are creating a way for people to invest in the market without actually buying and selling diamonds," Shoushan said.
A quarter of the market value of both coins will be backed by diamonds held by a third party. All this, he said, should make the tokens "much less volatile compared to any other cryptocurrency."
In the high security four-tower complex on the outskirts of Tel Aviv, $23 billion changed hands between local and foreign traders in 2017. The area is known as the diamond district, and visitors coming by train access it across Diamonds Bridge.
Visitors are fingerprinted before they can enter the buildings and look down on the world's largest trading floor. Should a diamond go missing, the entire complex locks down.
Israel's diamond district is full of polishers who specialize in large, high-end diamonds. The country cannot compete in smaller stones with massive operations in India and China. The trade by nature is global. The State Bank of India has a branch beside the exchange.
Israel's diamond exports in 2017 fell 12 percent to $15.5 billion. Consultancy Bain said in a 2017 industry review that diamond jewelry sales, which according to De Beers hovered at $80 billion in 2016, were "stagnant".
Slowing long-term demand and the shaky financial position of polishers are two big concerns, it said.
Martin Rapaport, chairman of the highly influential Rapaport Group whose diamond price list is a global industry benchmark, has a big presence in Israel and may have to compete with the new system.
He applauded the effort to expand diamond demand, but told Reuters he thought cryptocurrencies were "a bit of a fad" and is unsure of their sustainability.
"Diamonds have an inherent value and that inherent value has been around for centuries. Whether or not you can take that and hype it into something modern and something interesting like a cryptocurrency is highly questionable," he said.
(This story refiles to add dropped letter from company name, paragraph 17.)
(Editing by Sonya Hepinstall)