Why you should care about fungibility

Monday 20 July 2015

Are all bitcoins the same? Maybe, maybe not - and the difference is kind of important.

Fungibility, n: A good or asset's interchangeability with other individual goods/assets of the same type. Assets possessing this property simplify the exchange/trade process, as interchangeability assumes that everyone values all goods of that class as the same. 

Read also: Inside a bitcoin laundry 

Fungibility has always been a bit of a Thing for bitcoiners. Fungibility means that one unit of a currency or commodity is completely interchangeable with another. One $10 bill is the same as another $10 bill, one Troy ounce of gold is the same as another Troy ounce of gold, one cubic Smoot of wheat is the same as another cubic Smoot of wheat.

Wheat

Spot the difference. Can't? That's kind of the point.

When it comes to money, this is a big deal. You don’t want to find yourself in a position where one coin or note is somehow worth more than another of the same denomination. Neither do you want to have to spend time and money checking whether the money you receive is safe money. Business would grind to a halt.

Thus, whilst the law is generally clear on what happens when property is stolen (the thief has committed a crime, but it is also possible to sue subsequent recipients to recover it), money is treated differently. Money is money is money. If you happen to handle stolen money in the course of a transaction - as you no doubt have, given the amount of money that must have been stolen and recirculated, and the frequency with which we make transactions - you are not liable.

The blockchain, transparency and fungibility

Bitcoin works on the transparent ledger principle of the blockchain. Every transaction can be traced back to the block from which it was mined. That means, in many cases - short of using a mixer or some smart practice on the part of the criminals - stolen coins can be tracked, and exchanges and merchants can refuse to accept them. And that is a potentially serious problem to fungibility. What if a merchant accepts a bitcoin in the course of a transaction, only to find later that it was stolen at some point in the past, and now cannot be passed on to an exchange?

How will this property affect bitcoin’s usage and fungibility? That partly depends on whether the relevant jurisdiction sees it as property or as money - leading to the interesting possibility that a currency that ignores borders in its transfer might be treated differently, even in two jurisdictions where it is a legal means of exchange.

The question of fungibility and stolen goods also partially explains why the coins the Feds recovered from the Silk Road sold for such a premium over their market price: since they were handled and fenced by Uncle Sam, they were by definition sparklingly clean, whatever their provenance.

Where will this end? With some coins being tracked and restricted for all time? With a whitelist and a blacklist of transactors? Or with all coins being treated the same, regardless of prior owners? It’s just one of the many issues regulators still have to figure out.

 


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