Risks to Fungibility

Fungibility is a risk for Bitcoin. In theory, a bitcoin is a bitcoin is a bitcoin. But the fact that it is often possible to tie an identity to a Bitcoin address means that if the identity is an enemy of the state, then governments can attempt to dissuade people from accepting payment from that address. For example, on November 28, 2018, the United States Treasury publicly identified two individuals, Ali Khorashadizadeh and Mohammad Ghorbaniyan, as enablers of ransomware attacks using Bitcoin, and it blacklisted two particular Bitcoin addresses believed to be controlled by them.¹⁷⁹ It is possible that cases such as these could result in certain Bitcoin addresses being “tainted.” This could result in a bifurcation of the Bitcoin system such that bitcoins in tainted or blacklisted addresses might only be able to circulate in the black market, while untainted ones circulate unhampered.

There is also the question of how long a Bitcoin remains tainted. In the world of dollars, once a $20 bill has been transacted five or six times subsequent to its theft, it becomes impossible to repossess it because by then multiple innocent parties in the economy will have used it legitimately. For example, a thief may steal some cash and pass it to his friend the money-launderer who puts it through the books of his restaurant. Then the restaurateur/money-launderer uses it to buy a book for his daughter. Then the bookstore owner uses the money to buy a turkey sandwich at the deli, and the deli owner pays the man working at the counter. If the police were to repossess the “stolen” money from the deli employee, he would rightly be dumbfounded. He didn’t know anything about the theft that occurred four transactions prior.

It’s possible that bitcoins are viewed differently since in theory anyone could search a government database to make sure the bitcoins they’re planning to accept as payment for a good or service aren’t stolen or even weren’t stolen three or four transactions ago. It remains to be seen how this dynamic develops. One potential defense against such a development would be for Bitcoin users to deliberately interact with tainted addresses en masse. If enough Bitcoin enthusiasts were to swap bitcoins with tainted addresses, the pool of addresses might become so large that it becomes impractical for governments to attempt to blacklist so many people’s funds. It is believed that roughly 90% of all $20 bills in circulation carry traces of cocaine,¹⁸⁰ which suggests that those bills were used to buy or at least consume cocaine at some point. Since the vast majority of twenties are thus tainted, nobody worries about somebody refusing to accept one of these bills as payment.