How will digital currencies impact banks?

The European Central Bank (ECB) is reportedly accelerating its work on a digital version of the euro (the dEuro), having seen the US pass the Genius Act in July which paved the way for broader adoption of so-called stablecoins. The rise of digital currencies is an important development for the European banking industry, and by extension European bank bondholders. Here we look at how digital currencies work, and the potential impact their more widespread adoption could have on banks’ credit fundamentals.

What are digital currencies?

Digital currencies are intangible assets used as a medium of exchange outside of the traditional banking sector, typically managed through cryptographic or decentralised technologies. They include cryptocurrencies (e.g. Bitcoin, altcoins), central bank digital currencies or CBDCs (e.g. dEuro, dPound), or other forms of electronic money such as stablecoins (e.g. Tether).

These of course differ from the fiat currencies represented by physical cash notes. Electronic money in a traditional bank account represents a claim to receive paper notes; digital currencies cannot be redeemed for paper notes in the same way. In contrast to cryptocurrencies, stablecoins are designed to hold parity with a fiat currency (at present primarily the US dollar), and are in theory redeemable for cash, though restrictions and fees do apply. To give holders confidence that the exchange rate with USD will remain one-for-one, the issuers of stablecoins hold assets that are of similar value to that of the issued stablecoin, so in that sense they are backed by assets. That said, it is worth noting that holders of stablecoins do not hold a claim against any asset and are in this sense unsecured creditors of the private company that issued the stablecoin.

In short, digital currencies operate in a separate ecosystem outside of traditional banking networks, with a number of touted benefits (e.g. lower fees, faster settlement, greater anonymity) and some potential drawbacks (e.g. no deposit guarantee scheme, less regulation).

Why now for the dEuro?

Development of the dEuro is not new – it was first flagged as a project by the ECB in July 2021 – but work has reportedly been stepped up in response to the US Genius Act, which aims to provide better legal protections for customers using stablecoins.

One of the ideas here is that broader adoption of stablecoins globally would increase demand for them, which in turn would drive up demand for the collateral used to support them (primarily US T-Bills). This would obviously be helpful for the US government, which would benefit from fresh demand for its growing stock of public debt. Tether, which didn’t exist before 2014, recently disclosed that it is in the top 20 of US Treasury (UST) holders globally. The market capitalisation of stablecoins is now around $250bn, but the US Treasury Secretary, Scott Bessent, said in July that dollar-linked stablecoins could hit $2tr or more in the coming years – this would clearly create ample new demand for USTs.

A dEuro, unlike a private stablecoin, would be issued and backed by the ECB. This means the holders would hold an “IOU” from the ECB, similar in this sense to holding euro bills or coins, with no credit risk to individual banks (as with traditional fiat deposits) or the counterparty risk associated with private stablecoin issuers.

European authorities are accelerating the dEuro project for fear that wider usage of stablecoins globally, including within Europe, would bolster the dominance of the dollar as a global currency (stablecoin issuers would need dollars to buy T-Bills). This could also pose a challenge for the ECB with respect to its ability to ensure effective monetary policy transmission, in a scenario where stablecoins are widely used but there is no euro equivalent. In an increasingly polarised world, there is also some recognition that the continent could develop its own payment systems, as opposed to relying on the vast networks of US firms such as Visa and Mastercard.

Put simply, falling behind in the digital currency race in a world where physical currencies could be marginalised would leave the ECB less able to control the money being exchanged within the bloc.

How could digital currencies impact banks?

First, the rise of digital currencies (or assets of any sort, for that matter) are a potential new home for customer deposits. Indeed, there is a risk that during a period of banking sector stress, depositors could move their money outside of the banking sector and into digital currencies (especially those backed by a central bank, like the dEuro). Customers in the US have often moved cash into money market funds in periods of stress, for example, though for historical reasons these funds are not as developed in Europe. The ease of shifting deposits electronically from a troubled bank to non-troubled ones was actually one of the many factors said to accelerate the demise of Silicon Valley Bank. If in the future bank depositors can transfer their deposits (an IOU from the bank) into the dEuro (an IOU from the central bank) in just a few seconds on their phones, this could accelerate a larger liquidity crisis.

Second, in a world where an increasing number of payments was being done via digital currencies rather than banks (so in a separate ecosystem), the fee income from payments would naturally be reduced as a result. The degree of this reduction would clearly depend on the depth of the adoption of digital currencies. It is worth highlighting here that despite the modern payment infrastructure around Europe, over 50% of transactions at the point of sale are still done with physical cash (this is down from 59% in 2022, and the figure varies across individual countries).

Change is the only constant, and banks could obviously evolve into this new environment (we are already seeing reports of individual banks developing their own stablecoins) and capture some of the benefit from these changes. Still, as things stand, absent a bigger transition by the banks, we could see some erosion of their profitability in terms of both fees and interest income, albeit from what are currently strong levels.

How will banks combat deposit flow risks?

We believe the authorities are aware of the potential consequences around banks’ deposit flows should the dEuro become a credible and attractive medium of exchange vis-à-vis physical fiat currency.

We are also convinced the authorities understand the importance of the banking sector in Europe, it being a critical lending channel to the real economy in the region and an effective transmission tool for the monetary policy.

At this stage, the ECB is not planning to offer interest on dEuro holdings, which automatically makes the digital currency less attractive vis-à-vis remunerated bank deposits. The idea is also for the dEuro to serve as a medium for day-to-day payments rather than a store of value, and thus it is proposed that digital dEuro wallet holdings are limited to €3,000-4,000. For all the hype about the Genius Act and the US administration’s desire to increase the use of stablecoins, it includes an explicit ban on stablecoins paying interest that is clearly designed to protect US bank deposits and money market funds.

These concessions would allow the ECB to still roll out its digital currency, but at the same time better protect the interests of incumbent banks. The most likely net impact would still be some deposit outflow and the associated reduction in interest income, as well as some reduction of payment fee revenues, though again from what are currently strong levels.

Trust in new forms of money will take time

All else equal, the introduction of the dEuro and the rise of stablecoins would provide an alternative medium of exchange and greater potential for customer deposits to sit outside the banking sector. This would make the cost of funding higher for the banking sector, as banks may need to rely more heavily on wholesale funding from the markets, especially in a scenario where small, transactional deposits, which are very low-cost for banks, are removed and held in digital currencies.

We believe the impact will be manageable for banks. This is not only because of their generally strong current financial position (liquidity metrics well above requirements, profitability ahead of cost of equity), but also due to the importance of the sector to the European economy, which should underpin any legislative proposals around the final dEuro construct.

Importantly, the pace of digital currency adoption will be dictated by users’ trust in them as a medium of exchange versus the status quo. Trust in banks is underpinned by the deposit guarantee framework available in each country, but also the long-established brands with solid reputations locally (though the latter can be fickle as we have seen with Credit Suisse). Broadly speaking, consumers in Europe are generally satisfied with their current payment options, and convincing a retail audience of the marginal benefits of digital currencies may be a slow process in a world where over 50% of transactions are still settled with physical cash. However, the benefits might be more obvious in emerging markets, where access to a digital dollar may be valuable in devaluation-prone countries, or for certain transactions such as payment remittances, where fees remain high at around 7%.

Indeed, it is fair to say that digital currencies continue to be viewed with a degree of scepticism in Europe, due to their lack of deposit protection, the volatility of cryptocurrencies and the failure of FTX, despite the dEuro framework attempting to address some of these concerns. In a working paper from March 2025, the ECB noted that “a substantial portion of consumers report that they would likely not adopt the digital euro, primarily due to a strong preference for an existing payment method.”

Building the requisite trust in digital currencies could take years, even after they are rolled out. The ECB plan is to launch the dEuro by 2028 with the final design in place by the end of 2026, though this timeline could be accelerated given the new impetus behind the project. Banks have earned the trust in their payment systems over a long period of time, and digital currencies (including CBDCs) may require a similarly lengthy period or a generational change before they represent a credible alternative that threatens the existing ecosystem. This should give banks ample time to monitor and prepare for the transition, given their current solid financial standing and capacity to innovate in the digital space.