When you break a dollar bill into smaller denominations, you don’t usually think twice about whether or not those smaller bills are worth less than the original. In fact, you probably expect to be able to use them interchangeably. This ability to be exchanged for other units of the same value is called fungibility, and it’s an important property of money. Here’s why.
A Brief History of Money
To better understand fungibility, it helps to know a little bit about the history of money. In early societies, people bartered goods and services in exchange for other goods and services. But as civilizations grew larger and more complex, bartering became impractical. For example, if you wanted to buy a cow, you might have to offer several sheep or pigs in return—but what if the person you wanted to trade with didn’t need any more livestock?
To solve this problem, people began using commodities that were universally valued, such as gold and silver, as a form of currency. Gold was especially popular because it was rare and had many practical uses. For millennia, gold coins were used as currency all over the world—that is until 1971, when the United States abandoned the gold standard and began using paper or fiat currency instead.
What is Fungibility?
So what exactly is fungibility? Investopedia defines it as “the quality of being interchangeable with other assets of the same type. A fungible asset can be replaced by another identical asset since each unit is indistinguishable from another unit.” In other words, fungible assets are interchangeable—one dollar is worth exactly the same as any other dollar. Today, Bitcoin and Litecoin are not necessarily fungible. There is a public record of each transaction and how many bitcoin or litecoin are held in each UTXO. It's theoretically possible to have these UTXOs labeled as special or better than other UTXOs because these were mined "green" or even worse labeled as criminal if the UTXOs were stolen from an exchange hack. This labeling of UTXOs makes bitcoin and litecoin today less fungible.
Why is Fungibility Important for Money?
Fungibility is important for money because it allows bills of different denominations to be used interchangeably. Can you imagine having to carry around a sack of quarters every time you went to buy something? It would be incredibly inconvenient (not to mention heavy!). Having different denominations makes it much easier to conduct transactions on a day-to-day basis. Likewise, with Litecoin's new MWEB upgrade the UTXOs from the main chain are pegged into an extension block. This extension block essentially does a coinjoin and makes each litecoin in the extension block the same and interchangeable from the others. Users can then transact litecoin without the possibility of labeling making them fungible.
As you can see, fungibility is an important quality for Litecoin—but it’s not the only one. Litecoin like money is also durable (running decentralized network with 100% uptime), portable (any internet connection), divisible (down to 8 decimals), scarce (disinflationary and total fixed supply), and accepted by society in order to function properly as a medium of exchange (fast and low-fees).
With Litecoin now excelling in each of these areas, Litecoin is now better money.