Fungibility… a strange word, isn’t it? What does it mean? And how does it relate to cryptocurrency?
What is Fungibility?
Definition: Fungibility is the concept that something is interchangeable with another of “the same kind and same quality”. Fungibility is an important quality in the definition of currency.
Dollars, for example, are fungible, because one dollar is one dollar, regardless of which bank or merchant it comes from, or if you got it in a birthday card from your grandma. Additionally, gold bullion is fungible. One gold bullion is the same as another gold bullion (of the same weight).
Moreover, the property of fungibility also extends to goods, such as Apples. An apple is the same as any other apple, of the same kind and same quality. That is to mean, a red apple can be exchanged for another red apple; although a red apple is different to a degree than a green apple, and may therefore arguably be non-fungible with a green apple, but fungible with other red apples. While a subtle difference based on the definition, it becomes more pronounced when considering a rotten/expired apple compared to a freshly picked apple. The rotten and fresh apple are not of the same quality and therefore, not fungible. Also, your dog is not fungible with another dog. Your dog is very unique and specific, very not-the-same-kind-or-quality of another dog. Again, the same applies to hockey cards of different players, because each players’ card is unique.
Fungibility, as it relates to cryptocurrency, raises the question “is cryptocurrency fungible?” That is too broad and given the number of cryptocurrencies in existence and the myriad of use cases, the answer is both yes and no. So let’s get a little more detailed, shall we?
Does cryptocurrency need to be fungible?
A much better question. And the answer: that depends on the use case.
Cryptocurrency or cryptoassets are programmable value networks, let us not forget those definitions.
Cryptocurrency Use Cases That Need To Be Fungible:
If a cryptoasset is being used as a cryptocurrency, that is a currency, a medium of exchange, a unit of monetary measurement. Then yes, it most definitely needs to be fungible. Otherwise, people might refuse a token based on its history or uniqueness (i.e. if a bitcoin was used for illicit activity, someone might refuse it or accept it, but at a lower value). This is why as a medium of exchange, cryptoassets must be fungible.
Other use cases for value networks that would benefit from fungibility would be cryptoassets (smart contracts) as stocks and bonds, also known as security tokens. If you have a security token of say, “Apple” stock or “Facebook” stock, each share should be interchangeable in the same kind and quality. So that when you buy Facebook stock security tokens you don’t need to care which shares you are buying since they are all interchangeable and come with all the same stockholder rights, privileges and entitlement to company assets (book value) and income (dividend).
We acknowledge that each company issues different share classes, i.e. Class A shares vs. Class B or Class C shares, or Preferred vs. Common shares. Since the definition of each share class is that they come with slightly different rights, privileges, and entitlement to company assets and income, they cannot be interchangeable (fungible). Thus, the different class shares would exist as different tokens on different smart contracts, just as you can buy different types of shares issued from the same company today. Each share of a type would be fungible with shares of the same type.
The same applies to bonds (debt) issuance. Each bond token in securitized debt of the same type should be fungible.
Cryptocurrency Use Cases That Should Not Be Fungible
There are of course some use cases of cryptoassets that would not benefit from fungibility. Whenever a token is used to represent a uniqueness, originality or represent something very specific, it would not be fungible.
For example, in the tokenization of real estate, it would not make sense for a token(s) of one property to be fungible with a token(s) of another property. This is important for two reasons: your real estate token gives you the rights/ownership to that specific property and plot of land. Within your smart contract token(s) you will have the information on the property such as your landownership rights, the geographic location of the property/it’s address, the municipality it falls under, the property type classification (i.e. commercial, residential, industrial, etc) your taxation dues, and the value of your property will be reflected in the price of the token(s). This information, by definition, will be unique to each property and thus the tokenization of real estate should be non-fungible tokens.
Moreover, you may have a beautiful mansion with a heated pool, marble floors, 7 bedrooms, 12 bathrooms, theatre room, home gym, sprawling terrace meticulously manicured landscaping on a large 10-acre property. Another person may have a small bungalow with 3 bedrooms, 2 bathrooms on a relatively small suburban lot with weeds on their front lawn. Obviously, these properties are of different value and the tokens should not be considered fungible. Conversely, you may have a triplex property on a city lot that profits every year from rental income, which may be worth more vs. a comparable property of similar size and location.
Additionally, supply chain tokens should not be fungible to a degree. When using blockchain technology to design supply chains it would be important to create uniqueness among the tokenized items in the supply chain for the purposes of tracking for safety and service issues. While lettuce the produce or hamburgers the meat themselves should be fungible, the token representing them in the supply chain should have unique identifiers that allow them to specifically be traced. This would allow for very efficient tracking if there is a contaminated batch of food goods, allowing the source of the contamination to be traced, and all other distributions from that centre can be recalled for examination and safety. This can be done significantly more quickly with tokenized supply chains.
Other tokenized things that should not be fungible would be diamonds, jewellery, art, unique collectable tokens (i.e. digital baseball cards, hockey cards, pokemon cards, etc), some virtual in-game assets in the video game realm. These are all for obvious reasons. Jewellery and art are unique, as are collectable items. Some may be more or less valuable than others.
Their values can be denominated in fungible mediums of exchange whether it is the $USD, $BTC, $XRP, $ETH, or Gold.
To summarize, tokenized assets that need to be fungible are:
- Currency/mediums of exchange (i.e. stable coins)
- Stocks (of the same type)
- Bonds (of the same type)
And tokenized assets that should not be fungible are:
- Supply chain tokens
- Property tokens
- In-game assets
- Diamonds and other Jewellery
- Art tokens
Is Bitcoin Fungible?
Now to the question everyone has been waiting for. The answer will be dissatisfying to most people.
In order for something to be fungible, it must be interchangeable with another of the same kind and same quality. You could call it “equivalence”. Technically, any Bitcoin is equivalent to any other Bitcoin. They are the same kind. The question is around the same quality, based on one’s definition of quality.
It has been noted in the past that owing to the traceability of Bitcoins, some vendors or people have refused certain Bitcoins because they have or may have been used in illicit transactions (i.e. Silk road). This is only known due to the trackability of Bitcoins. However, every $USD has a serial number on it, and while the serial number is not recorded in (most) transactions it is plausible to presume that one could make the same argument against $USD. However, that is not the case. A $USD is a $USD is $USD, no matter what, even if it was used to buy drugs or was imported from overseas after being involved in terrorist activities. Therefore, in my opinion, I would argue that Bitcoin is fungible.
Furthermore, as the technology of scaling improves, it will likely contribute to the fungible quality of Bitcoin. For example, the Bitcoin Lightning Network routes transactions through the most efficient, quickest, channel, which could traverse the world, but which also adds a layer of complexity to tracking and enhances privacy. This would make Bitcoin transactions more of the same quality.
In my conclusion, Bitcoin, when used as a currency, is fungible because it is interchangeable with another of the same kind and quality.
Is Ethereum Fungible?
Another excellent question. This time, my personal answer is yes AND no.
Ethereum has many similarities to Bitcoin but also is very different.
ERC-20 tokens are classified as fungible. There is no difference between your Ethereum coin and my Ethereum coin.
ERC-721 tokens create uniqueness and are used for such. The most popular example was #CryptoKitties. Other examples include sports cards, other card collectables, in-game assets, etc (perhaps even real estate someday). Some ERC-721 tokens are whole and not to be broken into smaller fragments, such as #cryptokitties and baseball cards.
So, Ethereum ERC-20 is fungible, by design; and Ethereum ERC-721 is non-fungible, by design.
Is XRP Fungible?
Short and simple, yes.
The XRP token is totally fungible as each XRP token is equivalent to another.
I assume that with their smart contract platform Codius can create non-fungible tokens or contracts represented by XRP value? I have tweeted @Ripple as well as Brad Garlinghouse, David Schwartz, Alex Cobb and Digital Asset Investor for more info on this as I am having a hard time finding it online.
Cryptocurrency and Fungibility Conclusion
Basically, the fungibility (or interchangeability) of a token depends on its use case. Some tokens are fungible and others are not.
Bitcoin = Fungible
Ethereum: ERC-20 = Fungible; ERC-721 ≠ Fungible
XRP = Fungible
As a medium of exchange fungibility is a necessary characteristic. As a unique value proposition or tracking in a supply chain, fungibility is not good.
I hope you learned something from this post, as always, feel free to comment below!