Home Market Op-Ed On fungibility, liquidity, and the importance of decentralized exchanges

On fungibility, liquidity, and the importance of decentralized exchanges

At this point in the development of cryptocurrencies, it’s important to discuss three important concepts: fungibility, liquidity, and the importance of decentralized exchanges. We already know that a parallel economy can be established in order to complement and eventually replace the shortcomings of the fiat-backed world of finance. Furthermore, the ability to buy goods and services with our digital coins is at a historical high, and so far we’re not seeing any stop sign ahead. In time, our crypto economy will only grow and flourish, while its supposedly better ethics and practices elevate the entire space and make it much more attractive.

However, the crypto ecosystem is far from perfect and we always encounter shortcomings that are marked by reminiscences of the old financial world. The cypherpunk ideals often encounter greedy middleman practices, and in some cases, decentralization is nothing but a buzzword which means “stored on multiple computers”.

For instance, the fact that Bitcoin transactions are stored on an open ledger can be a threat to the idea of fungibility. Of all the qualities of sound money, this is the only issue that the king of cryptos encounters (and its carbon copies aren’t much better either): you can’t guarantee that your monetary unit gets accepted for payments in every situation. If you’re able to see that the Bitcoins you’re about to receive originate from a Silk Road transaction, then you can refuse to take them. But in the case of fiat currencies, you never know if the dollar bill in your pocket was previously owned by Pablo Escobar or Bob Dylan.

Also, we should make sure that the coins remain liquid and permanently retain a usefulness in both barter and mainstream commerce. Last but not least, our efforts should be focused on creating reliable decentralized exchanges which make no discriminations, freeze no funds, and deliver unfailing services for negligible fees.

On Fungibility

Creating an environment of trust where all cryptocurrencies are accepted regardless of their transaction history is paramount, though it can get pretty tough if governments get involved. In the case of fiat paper money, unless you find literal blood stains on the bills you can’t prove that they’re “blood money”. The lack of a transparent open ledger for transactions eases up fungibility and makes sure that a dollar can be swapped for any other dollar without any issues.

In the case of Bitcoin, you can actually trace back every little activity on the blockchain and see if your Satoshis once belonged to a wallet associated with Charlie Lee or Roger Ver. While this is good news for those who look for absolute transparency and advocate for a world of finance that’s void of secrets, it makes fungibility a lot more difficult to maintain.

The most extreme case can be that of criminal activity, usually related to drugs or human trafficking. It’s not your fault that the digital currencies in your wallet once belonged to a Columbian drug lord, and this fact doesn’t even mean that you’re in any way associated with their activities. But through specific regulations and oversight, an intrusive government can actually make use of force and either forcefully seize your coins or put you on trial for suspicions of criminal association.

This is why savvy cryptocurrency people must take their time and educate both their peers and their governments in regards to blockchain inventions. It’s easy to draw conclusions from superficial data and use the type of judgment which implies causation in small links, but it’s hard to implement sound and efficient public policies which find a middle ground between the interests of the government and the fundamental liberties of the citizens.

Let’s take our time and think of Venezuela, a country whose political regime has caused hyperinflation, and whose faulty foreign policy has brought a damaging trade embargo. The bolivar is losing value by the day, and cryptocurrency enthusiasts have created initiatives such as the Pale Blue Foundation in order to supply financial aid to the starving people of the South American state.

It’s important for these coins to remain fungible and not be subjected to sanctions and blockages from centralized exchanges which discover their origins and get pressured to seize them as soon as they leave the wallets of Venezuelans. Since the same international bodies which established the trade embargo have the political power to pressure centralized cryptocurrency institutions, having decentralized exchanges is paramount for the entire concept of uncensorable money.

On Liquidity

In the absence of liquidity, cryptocurrencies are nothing but expensive collectibles which only get traded for speculative purposes in a small circle of enthusiasts. It’s essential to not go back to the old days when Bitcoin had value only because a couple of people on the Bitcointalk.org forums agreed to engage in barter for a couple of pizzas.

Payment processors are essential in this sense, as they create a gateway to merchants and business owners from all around the world. Unfortunately, the process is far from the idealistic idea of taking out the middlemen: companies like BitcoinPay, GoCoin, and even Coinbase are an essential component of the ecosystem. It’s hard to convince the owner of the grocery store in your neighborhood that they can sell a loaf of bread and a carton of milk for 0.001 BTC. The local pizza place most likely won’t agree with you that Litecoin is digital silver that’s worth holding on the long term, so they should provide you Italian cuisine specialties in exchange for promising digital tokens.

Merchants and businesses are still coerced by government regulations, and they have to be accountable with every item which they sell. They must pay taxes and set prices according to an imposed national currency which serves as unit of account. This is exactly why cryptocurrency payment gateways are required: they provide quick and cheap services which convert your coins to fiat and transfer the money in the business’ bank account. Ultimately, thanks to their services the merchants will no longer care if you pay by credit card or BTC, as to them it’s the same process and they get the exact same amount of money through the same centralized banking services.

Then again, we should regard payment gateways as a temporary solution towards mainstream integration of cryptocurrencies. As soon as we develop a healthy and sustainable economy of trust which generally acknowledges that 1000 Satoshis are worth a candy bar, we should return to our initial ideals of decentralization. This moment will probably come further down the line, when the inflation of the total supply slows down and the price volatility becomes negligible.

On Decentralized Exchanges

Decentralized exchanges are the engines which push forward both fungibility and liquidity. The idea of using a service which doesn’t take into  account the origin of your coins and has no means of freezing them under political pressure is exactly what serves the ends of this decentralized economy.

Maybe that executives and public relation officers from centralized exchanges like Coinbase and Binance will defend their business model by saying that there is no history of governments seizing the funds due to their origins and association with criminal actions. The worst-case scenario involves getting their databases hacked, but that’s also something they will refute by pointing out to advanced security systems (despite a long and well-documented history of centralized exchanges getting hacked and having funds stolen).

The argument for decentralized exchanges doesn’t justify or endorse criminal actions in any way: if governments truly find dangerous actions from individuals who trade cryptocurrencies, then they have physical means to intervene and they can make use of their laws to get possession of private keys or convince other honest citizens to willingly return stolen funds. But as Andreas Antonopoulos mentioned in his October 2016 speech at the Merkle Conference in Paris (in the segment which he titled “How Is Fungibility Tied to Privacy?”), it’s usually the clueless and innocent people who get caught and may get accused of actions they have no technical actions to perform. Criminals are more careful, and use means that the everyday Bitcoin user cannot understand – otherwise they wouldn’t be able to succeed in their actions.

The only issue with decentralized exchanges is that they cannot operate with fiat currencies, so the only trades can be made between various supported cryptocurrencies. Up to this point, crypto to fiat conversions require a centralized authority which registers the transaction and makes it compliant with the government’s policies.

There are still gateways to acquire cryptocurrencies with fiat without using your credit card or complying with KYC regulations, though. In some states you find Bitcoin ATMs which allow you to make small purchases with your cash, and there is always the possibility to find a local cryptocurrency miner or enthusiast who is willing to sell you some coins. If you want to maintain your privacy and make sure that your oppressive government doesn’t get in the way, it’s probably a good idea to use these solutions, and then obfuscate your transactions or use decentralized exchanges to get privacy coins like Monero or Zcash.

Essentially, as soon as we see a stabilization in the prices of cryptocurrencies and people acknowledge their value in relation to goods and services, we will be able to ditch centralized gateways, processors, and exchanges. That will be the moment when fungibility and liquidity will reach their absolute peak, and one can only look forward to the realization of Satoshi’s dream for a decentralized economy. Unless we keep these ideals alive and aim to attain them, we’re going to get doomed by greedy and oppressive governments, while centralized services rip us off with arbitrarily high fees which speculate the supply-demand chain. Cutting out the middleman is and should remain on our roadmap to economic freedom.

The above is to be considered opinion and not investment advice in any way, as an unbiased media, no one interferes with the Editorial content of CryptoInsider.com, writers have freedom to choose their own direction, members of Crypto Insider do not participate in trades based on content.

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Vlad Costea
Vlad Costea
Vlad is a political science graduate who got a little tired and disillusioned with the old highly-hierarchical and centralized world and decided to give this anarchistic blockchain invention a little try. He found out about Bitcoin in 2014, had to do a presentation about it at Sciences Po Paris in 2015, but was too foolish to buy any. Now that he’ll never be a crypto millionaire and hasn’t acquired his golden ticket to lifelong financial independence, he’ll just write op-eds on various topics.

1 COMMENT

  1. […] The development and enhancement of Decentralized Exchanges (DEXes) are essential for the survival of digital assets. Centralized exchanges are the dominant means to exchange decentralized digital assets and, due to the repeated hacks and security breaches, this introduced a lack of trust into the ecosystem. Practical DEXes with the same or better functionality than centralized exchanges may bring in larger trade volumes, and as hacks start to diminish given that decentralized exchanges does not store critical information on centralized servers. This in turns will facilitate the adoption of this new class of assets. DEXes are also a crucial component for an increased degree of fungibility in cryptocurrencies, if you’d like to read more, refer to this article “On Fungibility, Liquidity, and the Importance of Decentralized Exchanges” […]

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