Fungibility

Spend enough time browsing Bitcoin-related forums and blogs, and you will eventually run into someone talking about the bitcoin's Fungibility.

If you are not already familiar with the term, fungibility refers to how interchangeable individual units of a commodity or good is. For example, a pound of gold has the same value as any other pound of gold. The form of the gold being traded is irrelevant. Fiat currencies are also fungible. That is what allows them to function so well all over the world. A dollar is a dollar regardless of if you have one paper note or four quarters.

Fungibility should not be confused with liquidity since these two terms mean completely different things. Liquidity means how easily a good or commodity can be exchanged for other goods or fiat currency. Fungible assets require one unit to be equal in value to another unit of the same asset in the same quantity.

Fiat currency is the best example for most people to get their heads around the concept of fungibility. A 20 EUR bill is fungible since it can be easily interchanged with two 10 EUR bills or four 5 EUR bills. 

Fungibility is one of those measuring sticks that separates Bitcoins and other cryptocurrencies from fiat currencies. Surprisingly, Bitcoin is not fungible the way fiat currencies are, Sure, one satoshi has the same value as the next satoshi, but Bitcoins leave a trace on the blockchain whenever they are transferred between wallets.

Clean Bitcoins and Fungibility

"Clean Bitcoins" tend to be worth more than the typical BTC on the blockchain since they have no history linking them to any particular wallet. Mixing services have emerged to service people who are willing to pay a little bit more for Bitcoins that have no ownership history.

The behavior of some of the major Bitcoin exchanges like Coinbase certainly has a lot to do with the demand for clean coins. Some of these exchanges have been known to freeze accounts that receive or send payments to wallets addresses on their blacklist. Whenever an asset or currency is monitored and traced, it becomes less fungible. While there is a huge misconception among those new to cryptocurrencies that Bitcoin is anonymous, that is not the case in reality.

It’s actually the opposite. The transparency of the blockchain is what prevents Bitcoin from being fully fungible.

Protecting Bitcoin's Fungibility

In order for Bitcoin to become a success as a globally accepted method of payment. Its fungibility needs to be protected. It certainly won't be an easy process given how determined the major players like Coinbase are to monitor everything their clients do with their cryptocurrencies.

Fortunately, there are several Bitcoin-related and other cryptocurrency projects that are being developed to address this issue. Bitcoin's Lightning Network is expected to give users the option to make transactions that will not be recorded on the blockchain.

TumbleBit plans to provide a service that allows users to make anonymous transactions, while MimbleWimble is developing a protocol that lets users remove transactions from the blockchain.

Bitcoin isn't fully fungible nowadays, but it likely will be sometime in the future.