North Koreans are reportedly entitled to change up to 150,000 old won to new won, at a rate of 100 to 1.
Under current black market rates, 150,000 won is worth about $60.
Cash in excess of the allowed amount has to be saved in government-run banks, South Korean media said, although it was not clear whether residents would be able to change that money as well into new bills.
According to South Korea's Yonhap news agency, the surprise announcement sent many North Koreans rushing to the black market to convert hoarded bills into US dollars and Chinese yuan.
|The switch is thought to be part of a crackdown on unregulated private markets [Reuters]
Shops, restaurants and other businesses have closed while the switch is taking place.
Groups in South Korea with contacts in the North say the move has hit private market traders with large hoards of the old currency particularly hard.
In one case guards blocked the entrance to a bank in the city of Hoeryong after a stampede of people trying to offload old banknotes, the Seoul-based Network for North Korean Democracy and Human Rights said, citing unidentified sources.
Analysts have said the surprise switch appears to be part of a government crackdown on private markets, which have become an essential part of the food-supply system in aid-dependent North Korea.
The markets, which have gradually emerged across North Korea in recent years, have become a profitable business for some traders.
But their growth outside of government controls is believed to have unnerved authorities.
Faced with mounting food shortages, rigidly-controlled North Korea began allowing some private markets including farmers' markets to begin trading in 2002.
The markets have encouraged trade and boosted the supply of food, but they also become a source for banned goods such as films and soap operas from South Korea, which the government sees as a threat to its rule, analysts say.
North Korea's largest wholesale market, in the capital Pyongyang, was reportedly closed in mid-June.