In economics the term ‘fungibility’ refers to the interchangeability of goods. One US dollar is supposedly equal to every other US dollar – holding time and place constant. Here I discuss a few goods that have been used in different societies as a medium of exchange and reflect on their fungibility or lack thereof.
Let’s start briefly with seashells, which have been used as mediums of exchange in various parts of the world. An aesthetically-appealing seashell in good condition will generally be more well-accepted than one that is ugly and worn. Seashells can therefore be said to not be fungible. A currency must maintain homogeneity to achieve fungibility. That is, one must be just like every other if it will be subjectively valued equally to all others. The same can be said for stones, beads, tin ingots, feathers and anything else of this nature that has been used as a medium of exchange.
Observations from Prisoner of War (POW) camps during WWII
RA Radford’s paper “The Economic Organisation of a P.O.W. Camp” recounts from first-hand experiences how cigarettes spontaneously emerged as a currency among Allied prisoners inside German-controlled POW camps during World War II. In Radford’s own words: “cigarettes rose from the status of a normal commodity to that of currency.” Machine-rolled cigarettes were the most widely-accepted, and hand-rolled cigarettes were more scrupulously inspected for appropriate size and weight. (As a side note, Radford also explains that “tinned milk, jam, butter, biscuits, bully, chocolate, sugar, etc.” — all included in Red Cross food parcels — were also used as mediums of exchange as were clothing and toilet requisites). Radford describes the “lively trade in all commodities,” but their prices were not quoted in one for another but rather in terms of cigarettes. Gresham’s Law (the tendency for bad money to drive out good) also came into play. Higher-quality cigarettes tended to be used for smoking — not for currency.
Economists will often use the US dollar as an example of a fungible good. And to an extent, it is. “A dollar is a dollar” they say. But is it? Almost everyone prefers not to accept ripped paper dollars with writing all over them. They know that the next place they would try to spend dollars in this condition may not accept them as is. Fiat paper currency also contains serial numbers, which governments use to trace their circulation. Most people would likely prefer not to receive paper currency as payment if they knew that the serial numbers had been associated with illegal activity, which could make themselves suspect to law enforcement. We also know that one of the old US 25-cent coins (‘quarters’) made of silver are worth more than their newer copper-filled counterparts — despite the fact that Uncle Sam says they’re both worth just 25-cents. The older silver quarters have additional value both as a collectors’ item and as a precious metal. Copper may have industrial value as a conductor of electricity, but its market value tends to be far below that of silver. With both paper and coin, we see that fiat currency is also not fungible.
Bitcoin’s public ledger allows for anyone in the world with an internet connection and a browser to visit websites like www.blockchain.info and be able to check the transaction history (to which addresses, from which addresses, when, and how much) as long as a wallet address is known. Newly-created coins are more valuable to most people than coins that have been spent on the darknet where drugs, weapons, counterfeit fiat currency, and a number saddening things that I will not mention are sold. People know that merchants may prefer “clean” coins. Clean coins are so-called “non-tainted” — meaning they have never been spent on the darknet or been used for illegal online gambling, etc. Even if the merchants have no preference regarding this, Bitcoin Payment Processors (BPPs) like BitPay that enable merchants to receive bitcoin as payment are rumored to disallow payments from tainted coins. For this reason, there exists such a thing as ‘mixing services,’ which allows a user to send bitcoins to it, mixes it with bitcoins from other people, then sends bitcoins back to the user. The mixing services tend to return to the users slightly less bitcoin than the users sent to the service. This allows the mixing service to earn a profit and makes tracing the bitcoins more difficult to do since adding the sums of, let’s say, two or three smaller returns in bitcoins will not equal exactly the amount that any particular user sent to the mixing service in exchange for clean coins.
Looking even more gloomy for bitcoin fungibility-wise is the relatively new emergence of more sophisticated blockchain analytics services such as Bitfury’s Crystal Pro, which intends to add a certain element of security for companies wanting to know a great deal more than just where and when bitcoins have been previously spent.
So, bitcoin is also not fungible. If it was, then mixing services would not exist, and payment processors would not disallow payments from some coins while allowing others. With bitcoin blockchain analytics services scraping the internet, collecting data about who owns particular wallets (when available) or at least which addresses belong to which online aliases, how those bitcoins are spent, etc. it furthers a market climate in which users and companies may increasingly need to be more cautious as to which bitcoins they are willing to accept as payment.
Monero enters the scene
Monero (coded as XMR) is a so-called altcoin cryptocurrency that offers complete anonymity. Transaction histories, including the balances of particular wallets, time stamps and the origin of transactions are not publicly visible for Monero in the same way that they are with bitcoin by way of its much more transparent public ledger. As such, it may be perhaps the only truly fungible currency to have ever existed. One cannot know where Monero coins have previously been spent. In order to avoid scrutiny from law enforcement, people may avoid using Monero altogether, or they may opt to stop using it after having used it previously, but this will not change the fact that each Monero coin is equal in purchasing power to that of every other. Monero coins cannot get dirty, torn, worn or broken as can seashells and fiat currency. Unless you or someone you know mined them yourself/themselves, you cannot know if they’ve been previously spent on the darknet or how old they are, but it wouldn’t matter anyway because nobody else would know when you spend them unless you told them. Monero does offer users a proof-of-payment option so that a sender can prove to a recipient that she made a particular transaction. To do this, she provides the recipient with the transaction ID and a secret transaction key. The recipient’s address is also necessary to view proof-of-payment, but the recipient has this already. Important to note here is that when viewing proof-of-payment on Monero blockchain explorers, the sender’s address is withheld along with the transaction history of the coins spent. So there is no need for the recipient to worry if the sender’s address or the coins have been used in past illicit activity. This ensures fungibility in a way that serial number-stamped fiat paper currency cannot offer.
Monero does offer a transparency option by way of a ‘viewkey.’ Every Monero address has a private viewkey associated with it, and anyone with the viewkey can view that address’s incoming transactions. For this reason, Monero is said to be “private, optionally transparent.” But by default, every Monero transaction is hidden from the world. Transacted amounts, sender and recipient addresses are obfuscated – thus ensuring its fungibility.
Zcash as a benchmark
One other cryptocurrency worth mentioning here that perhaps comes close to Monero in fungibility is Zcash (coded as ZEC). Zcash is capable of offering similar privacy to that of Monero but is for the most part used transparently. It has shielded addresses and transparent addresses as well as shielded transactions (similar to how Monero works for all transactions unless the viewkey is shared) and public transactions (similar to how bitcoin works for all transactions). The important factor here is that every Monero transaction is private by default unless a user goes out of their way to make transaction details known. Monero is therefore a truly homogeneous product, and as such it is fungible. “A Monero is a Monero.” With Zcash, transactions are optionally private. Transactions sent from shielded addresses obfuscate the sending address. Unfortunately for Zcash (strictly speaking in terms of fungibility), users must be running a full node in order to send shielded transactions. The multi-cryptocurrency Jaxx wallet, for example, is only able to send public transactions and provides no option for shielded addresses.
As part of the research that I conducted for this article, I reached out to the Zcash team to request the ratio for shielded vs. public transactions as well as the ratio for shielded addresses vs. transparent addresses. I was told that they do not share this information at this point. Zcash obviously has a lot going for it as a currency, but in terms of fungibility, it lags behind Monero.
To sum up the main points succinctly, not every seashell is equal to every other. The same can be said for cigarettes and items in Red Cross food parcels that were used as mediums of exchange in WWII POW camps. Due to transparency of bitcoin’s blockchain, this currency doesn’t survive the fungibility test either. Fiat currencies (including US dollars) for a number of reasons – including the fact that they are stamped with serial numbers – are non-fungible. Zcash could be fungible but isn’t due to the transparency of the vast majority of its transactions and the extra work and resources required to run a full node in order to send shielded transactions. But Monero seems to be a new beast altogether.
So while it is inaccurate to say that “A dollar is a dollar,” it is indeed accurate to say that “A Monero is a Monero.” Through complete privacy it achieves homogeneity, and through homogeneity it achieves fungibility.
I would like to thank the few people that provided valuable feedback for this article as it was written.