ON MONEY & FUNGIBILITY

“free populations select the most marketable good to use as a medium of exchange”

The decentralisation movement has gained significant momentum and cryptocurrency adoption has reached new heights. But concerns pertaining to the quality of money are too often ignored. The number of bitcoin owners has reached the hundred million mark, but how many realise that bitcoin is not anonymous but rather pseudonymous, or recognize the pitfalls of embracing a currency lacking fungibility? While bitcoin’s provable scarcity signifies a return to the tenets of sound money, its creator’s peer-to-peer vision ultimately proved short-sighted without fungibility because, without it, counterparty risk is created. Bitcoin’s fungibility issues come from the history that is attached to the coins. The insertion of trust requirements into transactions, facilitated by scrutinising a coin’s history, has the potential to splinter the bitcoin network, in the process increasing fees as a result of regulatory compliance costs. More alarmingly, a regulated and transparent blockchain inevitably transforms into a surveillance chain on which reputation travels. In order to prevent censorship and protect our natural rights to privacy, a fungible currency is not a luxury, but a necessity.

Money facilitates business on the market by serving as a medium of exchange, store of value, and a unit of account, commonly defined by the following attributes: Durability, portability, divisibility,  

limited supply, uniformity, and acceptability. The latter two of these attributes are directly impacted by a currency’s fungibility.

At their core, fungible assets are interchangeable. On the nonfungible end of the spectrum are fundamentally unique assets such as real estate and artwork. Conversely, precious metals represent physical fungible assets. Gold, for example, can be melted down and swapped without complication. As noted by Menger (1892), the adoption of gold and silver as forms of money throughout history can be partially attributed to the homogeneity of these materials. In order to satisfy Berg’s (2020) fungibility criteria, “each unit of a currency, or any commodity used in a money function, must be indistinguishable from others of the same denomination,” and “an individual unit of said currency must not be re-identifiable through time and change.”

The most widely adopted digital decentralized assets designed to serve as money are the likes of bitcoin and Litecoin, which are nonfungible in nature. Each Satoshi, the smallest BTC unit, possesses an accessible history on the network’s transparent ledger. Consequently, 1 BTC ≠ 1 BTC.

Imagine selling an automobile to a stranger who, unbeknown to you, earned their fortune peddling contraband on the dark web. Subsequently, when you attempt to deposit the proceeds of the sale, your funds are flagged by financial / governmental institutions by which your “tainted” bitcoins’ acceptability is destroyed without any wrongdoing on your part.

According to Mises (1953), “the subjective use-value of money, which coincides with its subjective exchange value, is nothing but the anticipated use-value of the things that are to be bought with it.” Economic calculations become increasingly difficult when ambiguity pervades the medium of exchange. Fungible monies maintain their purchasing power regardless of past use, thus eliminating uncertainty associated with future use. A transacting party’s faith that their money will be accepted by future counterparties ultimately is shaken without the certainty of fungibility. If we go back to our example above, the automobile owner would have to require proof of ‘future acceptability’ of the bitcoins he is to receive from the buyer though we never do such a thing when we transact p2p with fiat cash.

The long-term implication of this problem for bitcoin is a fracturing of the network on the basis of anti–money laundering (AML) laws. Regulations like this are not only designed to hinder criminal behaviour and prevent terrorist financing, but have been implemented by governments to extend state powers. A network split may occur strictly along a clean-dirty dichotomy or, in all likelihood, through the categorization of white, grey, and black coins. Based on the latter hypothesised taxonomy, white, or clean, coins, would be those held in custodial accounts (e.g., Coinbase, Gemini, or Binance). These exchanges employ stringent know-your-customer (KYC) requirements for their users. Grey, or questionable, coins, would be identified as crypto assets held in noncustodial wallets, where the owner has possession of their private keys. While these privately owned addresses don’t have any direct link to illegal activities, anyone who wanted to move their ‘grey coins’ onto an exchange would likely be forced to answer invasive questions about their identity and the source of funds. Lastly, any coins used on the dark web or for purchases labelled nefarious would be branded black, or dirty, coins. Coins of this sort would be immediately frozen if deposited into a regulated exchange.

Signs of a splintered bitcoin network can already be seen across the globe. In over adherence to government regulations, crypto exchange Bitstamp now requires users to provide information on

their net worth, nationality, proof of residence, and source of funds prior to allowing withdrawals. Proposed guidelines issued by the Financial Action Task Force (FATF), an influential intergovernmental body, have labelled peer-to-peer transactions between unhosted wallets higher risk. FAFT goes on to recommend enhanced recordkeeping by virtual asset service providers (VASPs) to mitigate risks when interacting with unhosted wallets. On Reddit and Twitter, there are numerous first-hand accounts of exchange bans for using mixers, which are tools designed to preserve privacy. As evidenced by these examples, grey coins are already viewed suspiciously. On the pristine end of the taxonomy, industry executives have claimed that virgin bitcoins, those freshly mined, with no transaction history, sell at a 10 to 20 percent premium. As a whole, it’s quite clear now that crypto assets of the same denomination are treated differently and that a hierarchy of value has emerged based on a coin’s history. Thus, 1 BTC ≠ 1 BTC.

Regulatory obligations have made the identity of the medium of exchange increasingly salient. An emphasis on coin history has naturally incentivized the formation of companies capable of identifying risks (e.g., Chainalysis or CipherTrace). In many cases, though, users are branded guilty by association, as these companies apply imperfect information in constructing risk profiles for privately owned crypto addresses. If this trend continues, the saleability of nonfungible currencies will suffer. In tracing the origins of money, Menger (1892) states that free populations select the most marketable good to use as a medium of exchange. This creates a reinforcing cycle that increases the demand for this type of good. Reductions in the saleability of bitcoin will ultimately negatively affect its desirability and its real-world uses.

The phenomenon of cancel culture and the rabid silencing of contrarian or dissident voices across social media is a dangerous precedent that sets the stage for the ubiquitous refusal of financial transactions based on prejudices by government officials. Regulated ‘White label’ financial institutions are now dominating the crypto currency ecosystem that was intended to break the stranglehold of financial and governmental institutions over the increasingly exploited, powerless and voiceless individual.

So be careful what you wish for. What if CBDCs become our money? Besides losing whatever little is left of our personal sovereignty over our money, when currency units contain a history, previous possessors’ crimes can become a noose around the neck of the innocent. Communities living under authoritarian regimes in particular are in grave danger in this regard.

On the positive side, there are still some blockchains addressing the issue of fungibility. For example, cryptocurrencies such as Monero, Zcash, and Dash all claim to provide crypto users with added layers of privacy and fungibility but, ultimately, crypto users themselves will determine in the long run which currencies – if any – provide the levels of privacy and fungibility to constitute money.

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