Fungibility

In finance, the term fungibility denotes the ability to replace a specific asset with another identical or nearly-identical asset for the purpose of transacting value. Fungibility is a defining property of currencies. In order for a currency to have value, all units of each denomination of the currency must have identical value and be as widely accepted.

For example, in order for a Swiss franc to be used as a unit of currency, every Swiss franc in circulation must be identical in value and acceptance. If, some Swiss francs were more or less desirable than others, the currency would essentially fork into two or more different currencies.

A currency may lose fungibility if, for example, specific units of the currency could be blacklisted by a government or by the community which uses the currency. The blacklisting of specific units of currency would result in those units being undesirable to users, and therefore losing in value. This would inevitably result in users migrating to a fungible currency.

Precious metals were adopted for use as currency because – unlike other goods whose value varied based on their quality and condition – their value was always identical. An ounce of gold could always be exchanged for another ounce of gold. In the case of fiat currencies, fungibility is ensured by a central bank, monetary authority or (in the case of community currencies) an interest group which guarantees that a unit of its currency can be exchanged for another, identical unit of its currency. A 100-franc banknote may be used to accomplish infinite different kinds of transactions without losing its value. A 100-franc banknote which has been used for purportedly immoral or otherwise undesirable purposes at some point in its lifespan can continue to be used to perform countless desirable transactions at its face value.

Fungibility is a key concern in the development and adoption of cryptocurrencies. Because blockchain transactions are permanently recorded, it is theoretically possible to trace the individual units of currency used in specific transactions. Because each individual unit of a cryptocurrency has a unique identifier, it is possibly for specific units to be blacklisted. If at any point it is discovered that a unit of cryptocurrency was used for a purpose deemed undesirable for the user community or a government, that unit may be blacklisted and lose its value, resulting in a loss of wealth for its current holder who may have absolutely no connection to the undesirable transaction. This would result in a loss of trust in the value of the cryptocurrency and a subsequent decline in adoption.

A number of cryptocurrencies have been developed which aim to maintain fungibility by preventing the tracing of individual units of currency back to specific transactions using encryption an obfuscation. The Monero cryptocurrency is one example of a cryptocurrency which incorporates features aimed at preserving its fungibility.

More on this topic:
Alternative currencies explained

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