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Fungibility refers to the ability of one object to replace another without any loss in utility, value, or other fundamental characteristics. The idea is most often attributed to money — one dollar can replace another dollar both in the sense of physical presence as well as for purpose. One extra dollar that is allocated to a certain expense frees up another dollar to be allocated to a different expense. Just like with traditional fiat currency, the idea of fungibility and non-fungibility also extends to the realm of cryptocurrencies and different tokens. However, unlike regular currencies, there are non-fungible versions of cryptocurrencies called tokens, which have the potential to revolutionize several different industries.
The blockchain is based on a handful of different technologies that work together in consort — decentralized ledger technology, permissions, smart contracts, and cryptographic consensus.
Blockchains are essentially decentralized databases with identical copies of the same database stored on different servers. These servers, called nodes, are all connected and able to communicate with each other in order to modify and update the copies of the database they host. This decentralized ledger is immutable so that once a transaction is recorded, it cannot be modified. This immutability is quite useful when it comes to proving asset ownership or whether or not a transaction was actually made.
Additionally, depending on the blockchain, different parties may have different permissions to access the blockchain, engage in transactions, and even host a node. There are a few different types of blockchains with different permission structures, but most of the networks dealing with fungible and non-fungible assets are permissionless, or public, blockchains. This means that people are generally free to engage in transactions as long as they don’t violate the rules that govern the different networks.
Next, smart contracts govern the way that members of a community, especially those involving non-fungible tokens, are able to interact with different digital assets and one another. Smart contracts are a hybrid of digital code and legal intent. They may stipulate that non-fungible tokens can only be exchanged for a certain type of cryptocurrency or that a certain percentage of proceeds from their resale must return to the creator.
Finally, in order to verify different transactions, the nodes that run the blockchain compete to solve cryptographic equations. By solving these cryptographic equations, a consensus is created among the different blockchain nodes to memorialize a transaction. This consensus validates the legitimacy of the transaction.
Within a blockchain context, fungibility has to do with the different metadata that accompany a digital asset. Some tokens have an extra set of metadata that distinguishes them from other digital assets even though they would otherwise be carbon copies. This presence or absence of this metadata makes the difference between a fungible token and a non-fungible token.
Fungible tokens are those tokens that can seamlessly be replaced with other tokens without any effect on their value. These tokens are frequently just cryptocurrencies whose function is to transfer value and nothing else. Bitcoin is an excellent example of a fungible token. One bitcoin can be exchanged for another bitcoin, and even though it’s not the exact same bitcoin, there is no loss of value or functionality.
Non-fungible tokens, on the other hand, do not share the same fungibility, which is, in nearly every case, a net benefit. NFTs solve the problem of carbon copies, which are essentially fungible. Items that were previously un-ownable due to their digital nature can now be alienable and traceable with verifiable ownership. Additionally, an individual NFT represents a single unit of account, and they cannot be further subdivided the way that fungible tokens or cryptocurrencies can.
There are several different NFTs that currently exist, each with a different use. Perhaps the most well-known type of NFT is digital artwork that can be bought and sold with various cryptocurrencies. While the idea may seem a bit strange, digital art has reached purchase prices that most physical art can only dream of. Several pieces created by different artists have reached into the range of tens of millions of dollars. Other popular types of NFTs are items of digital clothing. Large retailers like Nike, Vans, and even Gucci have sold and are selling NFT versions of their shoes. Users can “wear” these items in different metaverse environments such as Decentraland and SANDBOX.
The digital applications of art and wearables are excellent initial use cases for NFTs, but their real-world application shows promise to revolutionize many industries. Apart from acting as a separate class of digital asset, NFTs can also be digital representations of physical goods. Virtually anything non-fungible in the physical world can have a parallel virtual existence as an NFT.
One of the major applications would be digital identification, since each person is inherently unique and their identity non-fungible. NFT identification could be used in lieu of log-in credentials, ensuring the most secure permissioned access to date.
Other artifacts like insurance policies, real estate records, and medical records could also exist as NFTs. Bearing in mind that NFTs must exist on the blockchain, all of these important and valuable assets could be stored with some of the most asymmetrical security to date. Events like identity theft, home title theft, and even some instances of insurance fraud would become extremely difficult to perpetrate. These are only the current possible use cases. It is likely that the number and quality of use cases will only continue to increase as the technology continues to mature.
Fungible and non-fungible tokens make much of the blockchain economy function. NFTs can be understood as digital goods for sale on the blockchain while fungible tokens are the currency used to pay for them. However, fungible and non-fungible tokens are only a small portion of blockchain technology.
The Wharton School created the Economics of Blockchain and Digital Assets course to help financial professionals navigate the new environment created by blockchain. The blockchain certification course features more than 80 videos, seven industry-leading case studies, three crypto valuation models, and more. For more information on the program or to enroll, visit our information page to learn more.
This article is for marketing purposes only and does not intend to represent the opinions of the program.
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