Ballyshannon takes its name from Béal Átha Seanaidh, the mouth of Seannach's ford. The crossing of the River Erne here has been a strategic point for millennia. Other nearby sites speak to even deeper roots. A Neolithic tomb lies in the area. The grave of Aed Ruad, who was supposedly a High King of Ireland, sat atop the highest hill in town, called Mullaghnashee or Mullgoose. Saint Anne's Church, a Church of Ireland parish, was reportedly built on top of his burial mound. Nothing remains to mark the original tomb. The last vestige of the mound was destroyed in 1798, when a military fort was built on the hilltop. The eighteenth-century churchyard, and a separate paupers' burial ground, both went by the same name: Sídh Aedh Ruaidh, the Fairy Mound of Red Hugh. The Irish word sidh means fairy hill. Even in death, the place was understood to belong partly to another world.

The Annals of Ulster record that Vikings attacked nearby Inishmurray Island in 795. From there they used the River Erne as a route inland, burning Devenish Island monastery in 822. In 836, the annals report, all the churches of Loch Erne, together with Cluain Eois at Clones and Daimhinis at Devenish Island, were destroyed by the gentiles, the chronicler's term for the Norse raiders. In 916 and again in 923, a fleet of foreigners on Loch Erne plundered the islands of the lake. The Erne corridor was a Viking highway for a century, and Ballyshannon sat at its Atlantic end.

Around 1793, a young British Army officer named Robert Stewart lodged in the old Military Barracks in Ballyshannon. He was a young man, an MP for County Down in the Irish Parliament, and would later become Chief Secretary for Ireland, Foreign Secretary, and Lord Castlereagh. That night, looking into his bedroom fire, Stewart reportedly saw the form of a boy emerge from the flames, grow larger and larger, and then vanish. The radiant boy is a known figure in English and Irish folklore, often understood as a death omen. The Ballyshannon poet William Allingham later wrote a poem about Stewart's encounter. Castlereagh himself died by his own hand in 1822, slashing his throat with a penknife during a period of mental collapse. The radiant boy, if it was prophecy, was a slow one.

In the 1950s, the Electricity Supply Board built a hydroelectric station upstream of Ballyshannon. The Cathaleen's Fall scheme involved damming the River Erne and digging out a tailrace channel that lowered the riverbed through the town. Before construction, the river had been wide, the water level much higher, and the long bridge from the northern shore to the port on the southern bank had spanned a flow that tumbled over a series of waterfalls, including Assaroe Falls, before meandering to the sea. The dam transformed all of that. The river now runs through a narrow channel far below the level of either bank. A narrower single-arch bridge has replaced the old one. The decade-long construction brought engineers and electricians from across Ireland and abroad, and the town experienced a building boom that locals still talk about. Then the workers left, the falls were gone, and Ballyshannon settled back into being a quiet market town.

Rory Gallagher was born in Ballyshannon on 2 March 1948. He left as a child but his family connections to the town remained strong throughout his career. He became one of the most respected blues-rock guitarists of his generation, releasing albums through the 1970s and 80s, touring relentlessly, and influencing musicians from Brian May to The Edge. Gallagher died in 1995 at the age of forty-seven. A bronze statue of him, guitar slung low, now stands in the town centre. Every June Bank Holiday weekend, Ballyshannon hosts the Rory Gallagher International Tribute Festival, drawing fans and musicians from around the world. The August Bank Holiday brings the Ballyshannon Folk Festival, one of the longest-running folk festivals in the world. For a town of just over two thousand people, Ballyshannon punches considerably above its weight.

During the Second World War, the British and Irish governments quietly agreed to create an air corridor between Belleek in Fermanagh and Ballyshannon in Donegal. The Donegal Corridor allowed Royal Air Force flights from Northern Ireland to cross neutral Irish territory on their way to the Atlantic. Catalina flying boats based at Lough Erne used the route to hunt U-boats far out in the western approaches. One of those Catalinas spotted the German battleship Bismarck on 26 May 1941, an intercept that led directly to the ship's sinking three days later. The corridor was one of many ways that Ireland, while officially neutral, helped the Allied war effort. Plaques in Ballyshannon and Belleek commemorate the agreement today. The flying boats are long gone, but anyone driving the N15 across the river still passes the route they used to disappear into the Atlantic sky.