A Brief Explanation of the Effects of Digital Currencies on Traditional Financial Systems

The impact of digital currencies on traditional financial systems is wide-spread and far reaching, influencing key areas like foreign exchange, loans, and insurance. Digital currency spans a spectrum from centralised models like Central Bank Digital Currencies (CBDC’s) to decentralised forms such as cryptocurrencies. CBDC’s and cryptocurrencies are reshaping the financial landscape. As a middle ground, stablecoins aim to combine centralised systems with decentralised systems, though widespread adoption remains nascent.

In 2009, Bitcoin was created as the first cryptocurrency to use “decentralized networks based on blockchain technology” (The Investopedia team et al, 2024). This bypassed intermediaries like banks to process transactions without the burden of fees and lengthy processing. This poses threat to the traditional financial system. The cryptocurrency market continues to grow, valued at around $3.27 trillion in December 2024 (Forbes, 2024). In response, transaction prices in banks have fallen. However, the threat is weak as cryptocurrencies are inherently volatile and insecure, leading to money laundering and tax evasion in some cases: “North Korean groups have stolen $1.34bn through cryptocurrency hacks” (Walker, 2024). Consequently, due to cryptocurrencies’ unpredictability, they are not a viable threat to the traditional, secure financial system in place now. Cryptocurrencies complement, not replace, the financial system.

On the other hand, the introduction of the CBDC, e-CNY, by China enables its government to have more control over its monetary policy, eliminating the defects of cryptocurrencies. Commercial banks facilitate the flow of e-CNY from the central bank to users. Since its release, there have been billions of e-CNY transactions across Shenzen. The e-CNY opposes traditional banks as there has been ‘decreased payment service charges for banks’ (Pan, 2024, p184). So, banks face shrinking deposit bases, impacting their funding, loan capacity, and liquidity. To adapt, banks are “collaborating with FinTech companies and advancing their digital transformation to enhance competitiveness” (Pan, 2024, p184). Therefore, the e-CNY has been successful at driving competition and public monatery control. However, due to the Mastercard and Visa’s credit card duopoly, the West remains skeptical about CBDC’s implementation.

Conversely, Stablecoins draw on aspects of both centralised and decentralised systems. While originally promising worldwide success, they have barely impacted the traditional financial system.‘A stablecoin is a cryptocurrency whose value is fixed to another asset’ (Royal et al, 2024) to decrease volatility in pricing while still providing lower transaction costs and financial inclusion. However, the initial offering of Stablecoins failed. Libra was created by an association of 28 companies such as Facebook and Ebay in 2020. It promised to supply “1.7 billion adults globally who are unable to access a traditional bank” (CFI team et al, 2022). Because the associated companies had access to the transactions, concerns were raised regarding consumer privacy and money laundering by governments. With Libra being wound down in 2022, it is safe to conclude Stablecoin has made minor impact on the traditional financial system.

Ultimately, by utilising digital currencies, traditional financial systems are ever-evolving. Cryptocurrencies have had the biggest impact on the finacial world with the establishment of a decentrialised financial system. CBDC’s are starting to turn heads in China, but to date have not impacted the West and Stablecoins have had minimal influence. Overall, with complex and dynamic effects, digital currencies are guiding the financial system into a new era of decentralisation.