Fungibility and the Importance of Peer-to-Peer Markets

There is a lot of buzz in the crypto community regarding non-fungible tokens and crypto kitty copy cats (pun intended), but few are talking about the importance of fungibility in regards to the original design of Bitcoin and other emerging crypto assets.

What is fungibility?

In basic terms, fungibility is a feature that implies an asset can be traded for another asset of the same kind without the risk of losing any value. For example, if I send Joe one Bitcoin which I received from Bob, and the Joe sends me one Bitcoin which he received from Alice, then I have the same value in assets prior to these events. Because Joe and I trust that all Bitcoin are worth the same value, I do not have to worry about ‘where’ or ‘how’ Bob and Alice accrued their Bitcoin. This is similar with US dollars. There is some statistic about how most dollars in circulation have been touched by drug dealers at some point, but I am on a plane with no internet writing this post, so I am unable to provide factual evidence at the moment — you get the point.

The fact that drug dealers have touched the dollar you used to pay for Starbucks this morning does not devalue the paper, and you can trust your dollar will always be interchangeable with all other dollars in circulation. This is fungibility.

So why is this concept so important? Let’s explore the alternative to make a point:

If Starbucks and other vendors were to enforce a new rule whereby they no longer accept dollar bills that have been touched by drug dealers, well then they would lose a lot of business. Theoretically “clean” dollar bills would be worth more in the marketplace. In a scenario where you received a dollar bill that you believed was “clean” and turned out to be “dirty”, you may only be able to receive $0.50 of “clean” money in exchange for your dollar. This is why fungibility is so important for certain assets like currencies.

How is Bitcoin losing fungibility?

I can make the argument that this exact scenario above has already started with Bitcoin. If you go to Coinbase and open and account, you will be asked to provide personal information and agree that Coinbase will be the custodian of your assets. Should you wish to withdraw your crypto assets from Coinbase, you will be monitored as to where you send those assets even multiple transactions after you have taken possession via a personal wallet. If you send your crypto through a dark web exchange or an online gambling site, most likely your account will be frozen along with your assets for an undetermined amount of time. Even if it is your friend’s account on the dark web which your are sending to, Coinbase will most likely still freeze your account since they are following irrational AML rules forced upon them by governments. Due to the limited utility of the Bitcoin coming from centralized exchange accounts, the value of those assets is reduced in the open market. Similarly, assets coming from gambling sites or the dark web are significantly reduced in value for those looking to accept those assets via a Coinbase wallet, as those account holders risk immediate termination of services.

How can we make certain that our crypto assets are fungible?

The answer here is quite simple, but unfortunately widely overlooked by most individuals today who own crypto.

We must hold our private keys and only interact via peer-to-peer markets in order to ensure the intended fungibility of these assets.

By removing the rule-making authority and third party custodian from interacting with our currency, we can trust the blockchain as a ledger where all assets are equal. The moment we give up our private keys, we no longer rely on just the blockchain, but put our trust back in the same hands we are removing it from in the first place.

The choice is ours.