In this article, I will explain the concept of fungibility in crypto.
What is fungibility?
We say an asset is fungible when it doesn’t make a difference to us which unit of it we hold.
Each unit is of equal value and identical and interchangeable with every other unit of the same type.
For example, if I hold a dollar bill I don’t care about which dollar bill it is exactly because I can easily exchange it for any other dollar bill.
Examples of fungible asset classes are fiat currencies, gold bars, and other precious metals and commodities such as crude oil, bushels of wheat, or megawatt-hours of electricity.
When fungible items are also limited in quantity, easy to move, easy to divide, and durable then they can serve as a medium of exchange.
This is why fiat money is such a popular medium of exchange. In the digital world, this role is taken on by cryptocurrencies.
There are plenty of examples of stuff that is not fungible.
For example, real estate, art, and trading cards such as baseball cards and other collectible items are not fungible. You wouldn’t trade your house for any other house just like the Louvre Museum wouldn’t exchange the Mona Lisa for my child’s painting.
Fungibility in crypto
In crypto, you have two types of digital assets: fungible and non-fungible assets.
Fungible crypto assets
Examples of fungible tokens are coins like BTC, ETH, and DOGE and tokens like USDT, DAI, and Shiba Inu.
Individual units hold equal market value and can easily be traded for one another on the secondary market on cryptocurrency exchanges.
There are two types of fungible assets in crypto: coins and tokens.
Coins are integrated into their own blockchain technology and used to reward validators or miners who confirm transactions or mine new blocks. Examples of native coins are BTC, ETH, SOL, ADA, and the like.
Tokens are issued on top of a blockchain. Anyone can create a token provided the blockchain allows you to do so. You can call the token what you want and define its supply and emissions according to the logic of code called smart contracts.
The first blockchain to allow people to create tokens was the Ethereum blockchain. Tokens on Ethereum are minted using the ERC-20 protocol and this is why people call them ERC-20 tokens. This is also the reason why ETH is not an ERC-20 token.
Tokens are frequently created as part of decentralized applications (dApps).
For example, Compound is a lending and borrowing dApp built on top of Ethereum. Users can post crypto as collateral and take out a proportion of it as a loan. Compound rewards borrowers and lenders in its COMP token which can then be traded.
Non-fungible assets in crypto
You also have non-fungible assets known as NFTs (non-fungible tokens). An NFT is a special type of crypto representing a unique digital asset.
They may be representations of digital artwork, digital collectibles, digital content, or even something as mundane as concert tickets with a serial number or bar code.
What’s confusing to many is that you can easily make a copy of an NFT art on your laptop. Why do I need to buy that Snoop Dogg NFT when I can just right-click and save a copy on my computer?
Well if you do that you have a copy but no one would be willing to buy it from you because you don’t have proof that this is the original file. Provenance plays a massive role in people’s minds. Owning an NFT proves that you have digital ownership of the original artwork.
The first NFT to ever be Minted was in 2014 when Kevin McCoy created “Quantum,” on a blockchain called Namecoin.
What caused NFTs to become popular was the launch of the Crypto Kitties game by Dapper Labs. This is the studio behind popular NFTs such as NBA Top Shot, NFL All Day, and UFC Strike.
NFTs really blew up in popularity with the advent of the Crypto Punk profile pics and then later the Bored Ape Yaught Club which led to the launch of Ape Coin by Yuga Labs.
NFTs are not just about digital cats and apes though. You can use them to represent identity, confer voting rights, and represent in-game items, or even real-world assets.
Fungibility and privacy
Fungible coins have been subject to concerns regarding their potential use in illicit activities, such as money laundering or financing criminal endeavors. Nonetheless, fungibility itself is not inherently associated with illegal activities.
Some argue that only privacy-focused coins such as Monero and ZCash are truly fungible.
This is because transactions on other non-privacy-focused blockchains are publicly available for anyone to check.
For example, if a hacker were to steal a bunch of Bitcoin from an exchange the government would be able to trace the journey of that Bitcoin as it moves about on the blockchain from one address to another and label it as illegal to accept on other exchanges.
If someone were to send it to you it would be equivalent to being duped with a torn dollar bill which you can’t use anymore. A torn dollar bill is not fungible anymore.
No one would accept it.
In a similar manner, in the world of cryptocurrencies, some crypto might be tainted as having been used for illicit activities. Hence not every unit of bitcoin is the same as every other. See Buying Bitcoin Anonymously for more on this topic.
Privacy-focused cryptocurrencies do not have this issue because you can neither see the origin of a transaction nor its destination.
Tumblers and mixers
Apart from privacy coins, there are other privacy-preserving tricks that people use to maintain the fungibility of their crypto.
Coin mixing, also known as CoinJoin, is a technique employed to enhance the fungibility of cryptocurrencies. It involves the process of combining multiple transactions into a single transaction. This obfuscates the origins and transaction history of individual tokens.
By mixing various transactions, coin mixing prevents the clear identification of which specific input corresponds to a particular output. This way you can have increased privacy and fungibility. Coin mixing is a powerful tool to preserve the interchangeable nature of cryptocurrencies and protect user privacy.
Why is it called fungible?
The term is derived from the Latin term fungi which means to perform as in perform a function.
What is an example of a fungible token?
USDT, DAI, and Shiba Inu are all examples of fungible tokens. You can easily exchange each of them for another of the same. For example, you would be indifferent about which USDT you hold as they all have the same value.
Is a diamond fungible?
No diamonds have unique characteristics such as carat weight, color, clarity, and cut. You would need to have each diamond appraised before you can exchange it for other diamonds.
Is fiat currency fungible?
Yes, all fiat currency is fungible as you would be indifferent which dollar bill or euro or yuan or peso you held.
Is money always fungible?
Fungibility is a desirable property of money because it makes transactions easy. But people have used non-fungible stuff for money. For example, when you pawn your watch you are effectively using it as a form of money but your watch is not fungible.
What tokens are non-fungible?
Tokens that are non-fungible are known as NFTs (non-fungible tokens). Each holds unique properties that prevent it from being traded 1 to 1 with one another.
Other crypto basics
- What Does It Mean to Stake Ethereum?
- What does minted mean in crypto?
- What is wrapping?
- What does a physical bitcoin look like?
- What is the difference between bitcoin and crypto?
- Why is cryptocurrency worth anything?
- What is the difference between bitcoin and bitcoin cash?
For more check out the crypto basics section on Elementalcrypto.com
Are you worried that your Bitcoin transactions are secretly being tracked? Bitcoin transactions are pseudonymous which means that if someone ties a bunch of numbers to your identity your whole financial transaction history could be exposed. The best way to maintain your privacy while using Bitcoin is to use a Bitcoin mixer or tumbler. In this article, I will help you find the best Bitcoin tumbler to suit your needs. Read more.