Understanding Fungibility: What It Is and How It Works

Fungibility is an important concept in the field of cryptocurrency. In this article, let’s deep dive into what fungibility is, how it works and why it’s so important.

The word fungible means being identical, which means that it is mutually interchangeable by the other item that it is identical to. An example of fungibility is money. A dollar bill is fungible because one dollar bill is the same as another dollar bill. If you give your dollar bill to someone and receive their dollar bill in exchange, nothing has really changed. These two dollar bills are mutually interchangeable. This is also true if you exchange a dollar with 4 quarters from someone less. It won’t make a difference because in terms of value a dollar bill is the same as 4 quarters. You won’t think twice about whether this has any impact on the value or quality of the money you have. Fungibility is common in commodities as well. Fungibility is the key characteristic of cryptocurrency. One bitcoin is the same as another bitcoin. The same is true for any other crypto currency such as ETH.

What is non-fungibility?

In contrast to fungibility, non-fungibility is the characteristic that makes an asset unique such that it cannot be exchanged with another asset without assessing its qualities. Things such as art and real estate are considered to be non-fungible because each piece of art and each parcel of real estate is unique and different from another. The equivalent of art in the digital word is the NFTs (Non-fungible tokens). NFTs are unique digital assets (think images, videos, music) that are created and sold on blockchain networks.

Importance of Fungibility in Crypto

Fungibility is a crucial concept in cryptocurrency because it is important that each unit of crypto has the same value as another unit and both can be exchanged without any differentiation in terms of value, or the transaction history. This ensures that a cryptocurrency can be widely adopted just like money.

Fungibility and Privacy

Fungibility is also important for cryptocurrency because it enhances the currency’s privacy. You cannot trace the source of funds based on the currency’s transaction history. Unless someone reveals themselves, you cannot identify the parties in a crypto transaction. With fungibility in place, it really doesn’t matter where a unit of crypto came from. The history of the currency’s transaction is not important and has no impact on the value or quality or goodness of the unit. It’s the same as with real currency. If someone gives you a dollar bill, you don’t care who had that dollar bill before you, what it was used for, or any kind of history of the dollar bill. However, the same is not the case with non-fungible assets like real estate or art. If someone steals a piece of art, this history is important and the original owner of the art piece can recover it if they can prove it that it was stolen from them.

Can Crypto Work Without Fungibility?

Without fungibility, any form of money or cryptocurrency wouldn’t work as a reliable medium of exchange. Without fungibility, each unit of crypto will have a transaction history and some units will become tainted as they might have been used for illegal activity and for this reason people will be hesitant to accept these units while they will be okay to accept other units which are clean as per their history. This will make the currency very unstable. The whole idea that you can accept any dollar or bitcoin as they’re all the same wouldn’t exist. You would need to do due diligence on every unit of money that you are accepting just like you would on art or real estate. Moreover, governments will be able to monitor the transaction which will reduce its privacy.

This makes fungibility extremely important for the very existence of cryptocurrency.

Is Bitcoin Fungible?

Bitcoin is generally considered to be fungible because each bitcoin is the same as another bitcoin. There is no difference between two bitcoins and they are fully exchangeable. However, for bitcoin all the transaction history is recorded on blockchain, which makes it possible to trace the origin of the bitcoin to its creator. This has raised some concerns about its fungibility as some bitcoin units may have been linked to illegal activities and due to that some people may be hesitant to accept those units. However, it’s not so easy to do that and bitcoin is generally considered to be fungible.