Digital Disruption

Groundbreaking. Transformative. Threatening.

Digital currencies such as Bitcoin and Ethereum have disrupted traditional financial systems and revolutionized global finance. They have blurred the boundaries between technology and finance,  reconstructing the rules of money and challenging established banking structures while empowering people. For instance, digital currencies pose substantial threats to current regulatory frameworks despite providing decentralised, quick, and affordable alternatives for financial inclusion (Casey & Vigna, 2018; Lee, 2020). This essay thus addresses the convoluted effects of digital currencies on conventional banking facilities, considering their far-reaching impact on banking operations, monetary policy transmission, and systemic stability.

Digital currencies have capsized existing banking operations by enabling peer-to-peer (P2P) transactions and minimising dependency on intermediaries. Digital currencies function on blockchain technology, which permits direct transactions between individuals without necessitating a central authority, in contrast to the established paradigm where banks handle accounts and assist transactions (Nakamoto, 2008). This decentralisation helps lower transaction costs and maximises efficiency (Tapscott & Tapscott, 2016). Accordingly, lengthy processing periods and high costs of traditional cross-border transactions can be circumvented by adopting digital currencies for international remittances (Iansiti & Lakhani, 2019).

However, this is concerning for banks which may generate less revenue from transaction fees and foreign exchange services as fewer operations go through their system (Chiu & Koeppl, 2019). Additionally, clients now have alternatives to standard banking services, such as loans and savings accounts, due to the growth of digital wallets and decentralised finance (DeFi) platforms, increasing pressure on banks. 

The rise of digital currencies also represents the first true challenge to the monopoly of central banks over executing monetary policy. Central banks systematically dictate the money supply and interest rates. As digital currencies—particularly decentralised ones—function outside of this structure, it becomes difficult for central banks to surveil and regulate economic activity, and prevent fraud (European Central Bank, 2021). 

The proliferation of stablecoins further complicates the situation, weakening demand for national currencies and limiting the efficacy of monetary policy (Adrian & Griffoli, 2019). To combat these issues, multiple central banks are studying the establishment of central bank digital currencies (CBDCs), which combine the convenience of digital currencies with the security of governmental support (Bank for International Settlements, 2021).

The quick popularisation of digital currencies also casts doubts about financial stability. The unprecedented price volatility of cryptocurrencies could destabilise economies and create speculative bubbles (Cheah & Fry, 2015). The vulnerabilities of market overexposure to digital currencies are widespread. For instance, the value of Bitcoin soared from $29,000 in January 2021 to over $69,000 in November 2021 before abruptly falling (Szalay, 2021). Moreover, digital currencies can be pseudonymous, facilitating illegal activities like tax evasion and money laundering and making them operate in regulatory grey areas (Makarov & Schoar, 2020).

In conclusion, digital currencies have instilled a financial dilemma. They have certainly opened doors for increased innovation, functionality, and financial inclusion. However, they present serious threats to monetary policy, banking operations, and financial stability. Authorities must develop strong regulatory frameworks to strike a balance between disintermediation and the requirement for security. Meanwhile, banks must also embrace emerging technologies or be left behind as digital currencies dismantle the barriers of conventional financial transactions. The capacity of digital currencies and established financial institutions to successfully adapt and integrate will determine their ability to coexist as the global financial landscape changes.