Bitcoin is Not Fungible, Should It Be?
Originally published Aug 8, 2016
As the Bitcoin community flexes its maximalism, noting how absurd it would be to undo the recent Bitfinex hack via hard fork (like Ethereum did with the DAO hack), it is exclaiming that the fungibility of Bitcoin must be protected:
I agree that hard forks are dangerous. I agree that forking to edit the ledger to undo a theft sets a horrible precedent that comes with many problems. However, Bitcoin has never been fungible.
Public Ledgers & Fungibility Are Incompatible
After having been kicked off of Coinbase for using their exchange too much, and off of Circle for selling them Bitcoins that came from somewhere they didn’t like, I really started to think more about Bitcoin’s fungibility.
Is it reasonable to claim that Bitcoin can have a public ledger, immutability, and fungibility at the same time? No, it really isn’t. I’m not sure that the quality of each satoshi’s fungibility and its value are separable at all.
Satoshis have multiple facets that detract from fungibility. Due to the permanent ledger, satoshis literally do not even weigh the same, with great variance too. They all have different ages, different creators.
From the moment every bitcoin is mined, it has a human and social context. Every last satoshi has/is permanent and transparent record. Each satoshi is its ledger history just as much as a unit of account, and none of them can be interchanged with another as they all have distinctive histories, permanently.
Unlike fiat, Bitcoin is practical to track and has a living history in the ledger. Consider that many Bitcoin companies and federal agencies already monitor blacklisted coins and employ blockchain analytics companies. [note]In case you haven’t heard, also check out http://blockchainalliance.org/ The Blockchain Alliance
Bitcoin may seem fungible within its own protocol, but external entities are applying “taint” information to coins, making Bitcoin infungible in practice. Most large exchanges are automatically performing risk assessment on incoming customer coins. While it’s easy to claim Bitcoin also has obvious plausible deniability, that does’t matter to Coinbase, Circle, Cash App, etc. They are applying taint with enough confidence to close your account.
This means that the only place to sell your Bitcoin as if it were fungible is peer-to-peer, which comes with its own risks.
Confidential Bitcoin Transactions: For Better, or For Worse?
There are various proposals and plans out there for adding better fungibility to Bitcoin via ‘confidential transactions’. Most Bitcoiners would love to see this feature supported, but I worry whether they have considered all of the potential consequences.
The transparency and immutability of Bitcoin’s ledger provides each user with the assurance that the ledger is balanced and auditable. If we were to introduce confidential transactions on the main network, or introduce anonymity somehow, would every user be able to audit its authenticity?
If there is a flaw or exploitable aspect of how anonymity is implemented, might it fester undetected? Some devs assure me that the designs are mathematically sound and force accounts to stay in balance, but most people will have to just trust this is true, as we lack the ability to audit or test any of it.
More importantly, if we were to introduce confidential transactions on the main network, would government agencies and regulators humor Bitcoin, cryptocurrencies, and blockchains with the same tolerance as they do now? Might they see anonymity as the final straw?
I’ve always believed that people underestimate the power of governments to squash Bitcoin if they really wanted to, and if Bitcoin becomes an efficient, even profitable, haven for criminal finance, do you think they will pass favorable regulations and laws?
This is probably okay to the most maximal of Bitcoiners. After all, Bitcoin was made to replace the current system, and thus is always at odds with it. But do the rest care more about the BTCUSD value than how anonymous they can be?
Devs also note to me that confidential transactions may be optional and more costly than transparent ones, but I’m not sure that would put the network under any less federal scrutiny. Maybe confidentiality should only be relegated to a layer on top of Bitcoin, like Lighting Network channels, but even then I’m not sure whether that might cause all LN-tainted coins to be marked as suspicious.
Is an anonymous Bitcoin as valuable as a transparent one?
Is a confidential network as sustainable as a pseudonymous one?
Would a fork to add confidentiality features be contentious?
I don’t have the answers, but I feel these are important questions to consider in the pursuit of Bitcoin fungibility.
Please review these tweets for more info about which companies are actively tainting Bitcoin: https://twitter.com/BitcoinErrorLog/status/1012607780199510016