Understanding bitcoin fungibility

What is interchangeability? Are BTC fungible? Bitcoin exchange premiums: jurisdictional andfor confidentiality. How blockchain analytics works and the future of bitcoin fungibility.

What is fungibility?

Interchangeability is a property of a good orgoods, the individual units of which, in fact, are interchangeable. That is, a product is fungible if one of its units has exactly the same value as all the other units of this product.

Interchangeability is a desirable property formany goods, but for money it is necessary. If money is not fungible, then each monetary unit will have a different value, and money will cease to be an effective medium of exchange.

Divisibility [units of account into smaller shares withoutloss of value] is an important component of fungibility, especially for Bitcoin. Just as five $ 1 bills must have the same purchasing power as one $ 5 bill, the purchasing power of 1 BTC should not change depending on whether it is divided into one, two, or ten UTXOs.

Are BTC fungible?

Interchangeability is not a binary propertymoney; some products may be more or less interchangeable than others. As an apolitical money that knows no borders, bitcoin has achieved a significant degree of fungibility and is usually traded at about the same price around the world. However, government interventions, criminal activity, and technological differences sometimes resulted in some BTC being more or less valuable than others.

Bitcoin Jurisdictional Awards

In theory, in the bitcoin market, given itglobal nature, there should be no exchange awards. If the price of BTC on the two exchanges were significantly different, then traders would take advantage of the arbitrage opportunity, buying BTC on an exchange with a lower price and immediately selling them at a higher price on another exchange until the difference in rate is eliminated.

However, if imposed by governmentsrestrictions make it much more difficult and more expensive for traders to move BTC between certain exchanges, exchange rate premiums may persist. Government regulation of Bitcoin varies widely across jurisdictions. Some governments are more open to accepting Bitcoin and the innovation and growth it brings, while others are trying to ban its use as a currency in their territories.

As with most prohibitions and controlscapital, restrictions or prohibitions on Bitcoin do not completely exclude the possibility of its use in the jurisdiction. But these measures can create an exchange rate premium in the BTC market within the relevant jurisdiction, that is, in this territory, bitcoin will be traded more expensive than in the rest of the world. In Venezuela, Nigeria, Zimbabwe, South Korea and India, such restrictions have led to substantial exchange rate premiums at various times. In Nigeria, where the Central Bank tried to ban Bitcoin, the demand was huge, but due to the difficult access to international markets from Nigeria, there was a significant premium on the local market.

Bitcoin and privacy premiums

Geographic course awards are an example ofthat the fungibility of bitcoin may be weakened within a given legal jurisdiction. However, fungibility can also be lost between individual coins. This is not a significant problem today, but may become so in the future depending on government regulations and the privacy practices of Bitcoin.

Hypothetically, the valuation of individual coins candiffer from the rest of the BTC mass for several reasons. If the coin was received as a result of a well-known crime - burglary, fraud or other illegal actions - then some exchanges or companies may refuse to accept such coins as payment. As a result, these coins can be traded at a discount to the BTC market price. As of 2021, this remains extremely rare.

On the other hand, individual digital coins canbargain for a premium if they have a strong level of privacy. This trend is widespread today, especially on decentralized exchanges (DEX), which do not collect AML / KYC data from customers. Bitcoin users who value their privacy are willing to pay the exchange rate premium to purchase BTC without disclosing their identity to a counterparty, third party, or government.

Some digital coins can also becomemore valuable than ordinary ones due to some peculiarities in their history. For example, if Satoshi Nakamoto, the creator of Bitcoin, puts his BTC up for auction, then it can be sold at a price higher than the market price. This trend should become problematic for Bitcoin and, in fact, is similar to the two-dollar bills, which often trade for more than their $ 2 denomination.

How blockchain analytics works

For the most part, it is blockchain analysis andconfidentiality will be the driving force behind BTC interchangeability issues should they arise in the future. Since all Bitcoin transactions are recorded on the public blockchain, analytics companies and governments can analyze the history of coins and try to track coins that have already been used to fund criminal activities.

What are tainted bitcoins?

Coins that were used for fundingcriminal activities are sometimes referred to as "tainted". It is, at best, a probabilistic measure of how much a coin's past history is associated with some kind of criminal activity. "Corruption" is a subjective term and is used by various specialized companies whose blockchain analytics are based on heuristic methods and some assumptions.

The future of bitcoin fungibility

If Bitcoin completely loses propertyinterchangeability of digital coins, then its usefulness as money and currency will be significantly reduced, and the adoption of bitcoins to pay for goods and services will be difficult, hindering their distribution. Bitcoin's inherent censorship resistance also depends on the fungibility of its units of account. If a particular unit of account can actually be blacklisted or declared “non-bitcoin,” this implies that a) Bitcoin is subject to censorship and b) it is vulnerable to influence seizure.

Fortunately, several projects to improveBitcoin's privacy policy is constantly being worked to make ineffective the heuristics and assumptions that analytics companies use to flag specific coins as tainted. These privacy projects are important for keeping Bitcoin's units of account fungible and therefore useful as a global decentralized money.

In the future, an arms race between developersBitcoin on the one hand and analyst companies and governments on the other is likely to escalate as governments continually improve their observation and analysis methods, and Bitcoin developers create more powerful privacy protections and violate heuristics used in blockchain analytics.

Related Articles

• The Importance of Bitcoin Fungibility
• Bitcoin ownership and fungibility
• Bitcoin fungibility in 2017 (and beyond)
• 9 characteristics that make Bitcoin money

 

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