Cryptocurrency enthusiasts who have been actively involved in bitcoin discussions will have come across the term “fungibility” on more than one occasion. Unfortunately for bitcoin, fungibility is one of the traits this currency does not possess in its current forms. Some people see it as a drawback, whereas others feel it is no problem whatsoever. Let’s take a look at what fungibility means and how it applies to bitcoin.
WHAT IS FUNGIBILITY?
Fungibility is a trait of a good or commodity with interchangeable individual units. For example, one ounce or pure gold is equivalent to any other ounce of pure gold. It does not matter in which “form” these ounces are traded. A bar of pure gold is the same as freshly minted pure gold or an ingot of pure gold. Currencies, as one would expect, are fungible as well, as it allows them to function in the real world on a global scale.
It is important to note fungibility and liquidity are not the same by any means. Liquid goods or commodities can be exchanged for money or other different goods. Fungible assets or goods, however, require one unit of the asset to be substantially equivalent to another unit of the same asset of the same quality. To put this into simpler terms; a 10 EUR bill is fungible, as it can be interchanged for another 10 EUR bill, two 5 EUR bills, and so on.
Bitcoin is proving to be a very different creature in this regard. It is not fungible in the traditional sense, although there are some caveats. Individual units of bitcoin have the same size. One bitcoin is as valuable as one bitcoin, and one Satoshi is as valuable as another Satoshi. However, bitcoins leave a trace on the blockchain. So-called “clean bitcoins” are worth slightly more than any other coin on the network, as they have no history linking ownership of the coins to that specific wallet address. Some people are willing to pay extra for “clean coins” by using mixing services.
Moreover, bitcoin service providers, such as exchanges, can blacklist specific bitcoin wallet addresses. Any coins transferred to and from these addresses are worth less, due to their blacklisted status. The same principle applies to fiat currencies, though. Tracing and monitoring of any currency or asset makes it less than fully fungible. Keeping this knowledge in mind, it is crystal clear bitcoin is not anonymous, nor was it ever intended to be used as such.
To make bitcoin succeed as a global payment network, fungibility needs to be ensured at all times. So far, this process has been quite challenging. Just last year, blockchain forensics service provider Elliptic raised money to identify bitcoin transactions. Coinbase, on the other hand, has become extremely strict regarding the acceptance of coins with a murky history. While companies and merchants are not necessarily using third-party blacklist services before accepting bitcoins, it is evident there is a lot of work to be done before bitcoin can be fungible.
Several bitcoin-related projects under development will improve fungibility for this cryptocurrency. The Lightning Network will allow off-chain transactions, even though it is unclear when this project will be available to the masses. The Lightning Network does require SegWit activation, though, so it may be some time until we see it in action. Additionally, there is TumbleBit, which provides a tumbling service incapable of deanonymizing users. TumbleBit is expected to come to fruition later this year. Last but not least, the MimbleWimble protocol should not be discounted either, as it allows transactions to be removed from the blockchain.