That word, 'fungibility' (as overpopularised by NFTs) has been in the spotlight for long enough now that the word has become sort of irritating. It is a dumb word, you can't change my mind. It doesn't sound like it should mean what it describes. A lot of people out there will, by now, understand what 'Non-Fungible' means, in that it describes something that is 'one-of-a-kind'. I'm sure that many of those people, like me, wouldn't have known what it meant if we'd been asked a few years ago.
But that doesn't mean that the opposite of Non-Fungible is "many of a kind". There is a lot more to what fungibility really means, and it takes you right to the heart of what money is and what money is for.
I can't get straight into it though until I've first covered the reasons why the 'big 3' (Bitcoin, Litecoin and Ethereum) are NOT (quite) fungible, and explain that Bitcoin and Litecoin at least are likely to become much more fungible at some point before adoption can continue at-pace.
You can skip from this heading in bold 👇 to the next one, if you already understand why fungibility is currently a bit of an issue for public ledger cryptocurrencies.
Why aren't Bitcoin and Litecoin currently behaving like fungible assets?
The big 3 cryptocurrencies all lack fungibility to an extent. That's because they operate on public ledgers. Any BTC/LTC in any wallet can be traced back to the moment they were mined, creating an uneven playing field for each coin - in the eyes of some people, these coins are not all created equal. The moniker "Bloodcoin" has even started popping up to describe BTC mined in China and other areas with poor human rights records. Pro-fiat entities and those institutions that rely upon fiat to survive, are exploiting this issue to push exchanges and onramps into blacklisting certain wallets and even freezing some people's assets - all without proof that these blacklisted wallets have anything to do with the current owners of the frozen coins.
There are even people paying a premium for "fresh" Bitcoin with no price history, bought straight from the miners.
This is all an absurdity, but it's a predictable one. Currencies that suffer from low-fungibility often fail, meaning fungibility is one of the last hurdles that pro-fiat interests are definitely hoping BTC will fail to clear.
Bitcoin and Litecoin, though, are both antifragile. If pressure on their fungibility really starts to mount, they can (and will) evolve in response to this pressure to develop greater fungibility, primarily through privacy features. In fact, it has been suggested that the reason why centralised interests are not pressing this issue much harder, is out of fear that they might accelerate Bitcoin's evolution in this direction.
Enter: MWEB (Mimblewimble Extension Blocks)
Mimblewimble has an interesting origin story, a little bit like Bitcoin. Nobody knows who made it, as it was invented and published anonymously. Litecoin developers have modified this anonymously posted invention to create an optional, private sidechain that Litecoin holders will soon be able to use on command to obtain functional privacy.
This means:
No one will be able to see your balance on the block explorer. e.g., if you send a payment to someone, on MWEB this won't reveal your holdings and transaction history to that person
Transactions will be automatically mixed on chain using CoinJoin methodology, meaning the blockchain will not keep a record of how much LTC was sent, or where.
The addition of the Extension Blocks has the secondary effect of doubling the block size, meaning that Litecoin's maximum throughput will almost double. This is highly significant as it helps LTC play a greater supporting role whenever BTC is at maximum capacity, which has been known to happen, and helps it to scale.
The removal of a way of tracing coins back to their origins, also removes the ability of centralised exchanges to censor or blacklist those addresses. This directly improves fungibility and increases trust in the currency.
What is fungibility, then, and why is it underappreciated?
Fungibility is, really, all about interchangeability, but it's not about interchangeability of appearance. In other words, it's not about how much each unit of money looks the same or has the same size and shape. A counterfeit gold ingot can be made to the exact same size, shape, and density as a real gold ingot - but they are of course not the same value and therefore not fungible with one another.
No, it's not about appearance; fungibility is about the uniformity of the perceived value of that money. If you're deciding whether to hand over your crumpled and torn $1 bill or your crisp new one, you aren't thinking about how those dollar bills measure up against each other aesthetically. It's about whether they're 'worth' as much, with things like damage or markings detracting from their value just as they would if you were valuing an ornament or a piece of clothing. You also have to factor in the other person's opinion: if your dollar is too damaged, they likely wouldn't accept it. Fungibility is about consensus between the parties making the exchange.
All this still doesn't sound like a very big deal, but when you consider just how subjective the notion of value is, the idea of something having "uniformity of value" no matter who is perceiving it, is actually an incredible feat, and uniformity of value is exactly what the word 'fungibility' describes.
Think of all the factors that feed into how value is perceived between two negotiating parties. How valuable each person thinks the means of payment will be affected by judgement such as:
How likely is this money to be counterfeited?
Can I split this money up into a number of smaller transactions, or do I have to spend it all at once?
How long will this money last once I accept it?
How easily will I be able to store this money, and how safely?
How easy is it for others to acquire or create more of this money and devalue what I own?
How easy will it be for me to later transport and spend this money?
What markets will I have access to that accept this money?
All of these factors, and more, will modify your opinion, as an individual, of how valuable that money is to you, as well as the opinion of the other party you are trading with. A large difference in the perceived value between two individuals will spoil the trade and stop it going ahead, acting as a barrier to agreement during negotiation. This is why fungibility is important.
In other words, the factors affecting the uniformity of perceived value (aka fungibility) at the moment of exchange are things like durability, portability, divisibility, limited supply, acceptability ...
wait ...
...Those are all of the other desirable properties of money
Has fungibility been misclassified as one of the 6 desirable properties of money, when in fact, it is a single characteristic that summarises them all? You can't work on 'fungibility' in isolation - sure, you can make sure all of your dollar bills are the same size, but why does this matter? It matters because if bills were different sizes, people would have a preference, and preferences imply a difference in the perceived value of each bill between different people. If dollar bills were different sizes but this truly didn't affect the value, then they would remain just as fungible as uniformly-sized notes.
This is because the mechanism of action - the thing that distorts the value when you change the size of some fiat notes but not others - is the portability, or divisibility, or durability, or acceptability, or its ease of creation - not the change in appearance itself. Fungibility can't be directly altered.
Therefore all of the other properties of money are independent variables, but fungibility is a dependent variable. It is set by the interplay between the other properties, and by each individuals' own opinion of the value.
I would argue then, that fungibility is a key attribute in deciding whether one currency becomes adopted over another. Fungibility is the hardest attribute of money to improve, with many different factors feeding in. Ultimately the implementation of MWEB will provide increased fungibility to a mainstream ('Big 3') cryptocurrency which is more accessible and more widely accepted than any other non-BTC cryptocurrency (it can be acquired from cryptocurrency ATMs and from every major and almost-every minor exchange, for example, whereas privacy focussed coins are normally harder to acquire).
Considering the importance of fungibility in driving competition between different currencies and payment networks, it is reasonable to assume that from the moment Litecoin implements Mimblewimble Extension Blocks, until the moment that Bitcoin does, Litecoin will enjoy a significant advantage over Bitcoin or any other public-ledger cryptocurrency. If the above arguments are correct, fungibility is the most important characteristic of money on the open markets and until Litecoin's older sibling can make up for lost ground, Litecoin should - at least in the short term - acquire a powerful competitive edge.
Summary
Fungibility is about money being totally interchangeable (example, all 1 dollar bills have equal value) but this isn't anything to do with appearance.
What actually matters is the uniformity of the value of that money, which is set by many, many different variables and subjectively judged by each individual.
Having high fungibility means having a high uniformity of value, and having high uniformity of value means that, for various reasons, there is wider consensus among people that a given asset is money and that it does have value.
Wider acceptance directly translates into an improved ability to compete with other currencies on the open market, as seen in historical examples of one asset type supplanting another as the dominant form of money.
This idea of uniformity of perceived value captures the very soul of what money is. The whole purpose of money is to be something that everyone will readily accept. It is for this reason that fungibility seems to be the characteristic that drives paradigm shifts, causing one form of currency to be displaced by other, superior forms of money.
Fungibility-focussed improvements like Mimblewimble will provide a competitive edge to fungible cryptocurrencies over non-fungible ones, even if they are technically 'harder' forms of money.
For example, it is the high fungibility of fiat money that allowed it to compete against seemingly far superior stores of value, like gold. Gold investors have always been very high-conviction investors who are certain that they have the harder money, and yet, over decades, they have failed to make significant price advances versus fiat currencies, having largely moved sideways against them by market cap.
For example, in late 2021, gold was worth less than it was in 1980, adjusted for inflation.
The evidence repeatedly suggests that fungibility outperforms 'hardness'. Does this mean that LTC, as a softer, yet more fungible form of BTC, is set to outperform it over the medium to long term?
If the suggestions are true that better money leads to increased economic strength wherever it is predominantly used, then the most fungible cryptocurrencies will make for the most desirable long-term holds.
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