All you need to know about Fungibility
Fungibility, money and bitcoin. Let’s have a deep dive into fungibility.
Fungibility is a term of art that describes the characteristic of a good or commodity where its individual units are interchangeable with each other. For example, one-kilogram gold bar is the same as any other one-kilogram gold bar.
Likewise, banknotes that have the same value can also be considered fungible, in that one denomination will equal another one denomination. The concept also applies to intangible substances, like energy, where each watt is interchangeable with any other watt.
Fungibility also holds a contextual dimension. A ten-dollar bill is equal in value to ten one-dollar bills and are thus interchangeable in terms of purchasing power.
Fungibility and money.
Economists may have differing opinions on what constitutes money, but they do generally agree on some essential characteristics that a currency must possess for it to effectively serve as money. To be considered “sound money”, a currency must be durable, divisible, portable, uniform, widely accepted, have limited supply, and be fungible. Durability refers to the ability to withstand frequent use, while portability pertains to ease of movement. Divisibility means the item can be divided into smaller units. The final two characteristics, however, limited supply and fungibility, are more contentious among economists. For a good or currency to retain its value, it must have a limited supply, either naturally (e.g. gold) or artificially through the banking system (e.g. fiat currency).
Fungibility is an important characteristic of money, because it makes it easy to transact and exchange for goods and services, as the value of the currency is consistent and predictable. Furthermore, fungibility allows for efficient and fair market functioning, as it ensures that all units of a currency have the same value, regardless of their history or origin. This makes it easier for people to trust that the money they possess or receive is of equal value to others and can be easily exchanged for goods and services.
Fungibility and Bitcoin.
In the context of cryptocurrencies, Bitcoin’s fungibility isn’t inherently poor, but certain features of the Bitcoin network and the way it is used can create fungibility issues.
One of the main reasons is the transparent nature of the blockchain, which allows anyone to see the entire history of a Bitcoin address and the transactions associated with it. This can lead to certain coins being considered “tainted” if they have been associated with criminal activity, and thus being less valuable or more difficult to use.
Another reason is the existence of various forms of analysis and tracking tools that allow to trace the entire history of a coin. This makes it possible to identify blacklisted addresses, or coins that have passed through exchanges that perform KYC or AML checks on its users.
These fungibility issues make Bitcoin vulnerable to the actions of exchanges and other companies that may be arbitrarily reluctant to accept certain coins, or may charge higher fees for transactions involving coins that they consider to be “tainted”. here has been ongoing efforts to address Bitcoin traceability issues such as using CoinJoin, coin mixing, and other privacy-enhancing technologies (e.g. Confidential Transactions), but the effectiveness of such efforts are questionable.
Fungibility and scalability.
Fungibility plays a critical role in Bitcoin’s scalability, as it allows for the creation of more efficient payment systems, capable of handling multiple transactions without placing undue strain on the network. Additionally, fungibility helps to increase the overall liquidity of the Bitcoin market, making it easier for users to buy and sell the cryptocurrency. It is important to note that fungibility of money is not binary and varies among goods. Bitcoin, as a global, non-political currency, is significantly more fungible than others and usually trades at the same price across the world. However, government actions, criminal activity, and technological differences can result in some Bitcoin being more (or less) valuable than others.
Monero, a more fungible alternative.
Monero (XMR), on the other hand, uses various privacy-enhancing features to ensure the anonymity of its users, which not only makes it the leading cryptocurrency focused on private and censorship-resistant transactions, but also a lot more fungible than Bitcoin.
Its opaque blockchain ensures that one XMR will always be one XMR, regardless of its previous transaction history. Furthermore, unlike selectively transparent alternatives (e.g., Dash, Zcash), Monero provides protocol-level privacy to merchants and individuals using three important technologies: Stealth Addresses, Ring Signatures, and RingCT.
All coins are equally valued, interchangeable, and therefore fungible.