Fungibility

Fungibility, in finance, refers to any goods, assets, and commodities capable of being substituted with anything identical in type, nature, form, value, or function. Items that exhibit such property are gold and silver, sweet crude oil, bonds, shares, futures contracts, fiat money, digital currencies, etc.

The procedure makes it feasible to trade, exchange, or use goods and commodities in question. The only condition is that interchangeable products must be indistinguishable from each other in terms of value, quality, and utility. In other words, one unit of an item should be equal or uniform to another quantity of the same asset, regardless of its origin and ownership, for a substitution to occur. Fungibility is different from liquidity, where the exchange of a commodity occurs with anything of value.

• Fungibility is a property exhibited by any goods, assets, or commodities, making them eligible for interchange or substitution with anything identical in form, quality, value, or function.
• The criteria for something to be fungible differ based on the quality of the product and its noticeable impact on the worth and utility.
• Fungible assets are interchangeable, such as precious metals, sweet crude oil, bonds, shares, futures contracts, fiat and digital money, packaged products, etc. Automobiles, precious stones, gems, trading cards, and real estate are not interchangeable and considered non-fungible.
• Gold bars stored by the Federal Reserve Bank of New York are not fungible. It is because of purity markings and the need for the bank to return exact bars to the depositor when required.

People more often confuse the concept of fungibility with exchanging a particular item with any other product. Instead, it applies to the interchange of equal units of goods or commodities. Some considerations, however, come into play when deciding whether or not a fungible commodity is suitable for substitution.

In ancient times, people used to follow the barter system wherein one person would exchange their harvests for the products of others. For example, farmer A could exchange a unit of wheat for the required quantity of turmeric from farmer B. But in fungibility, a unit of wheat is interchangeable with the same amount of the same product of the same quality.

Sometimes, the term liquidity seems to be a fungibility synonym. But the two are different concepts. Liquidity defines the exchange of goods, assets, and commodities for fiat or digital currencies or anything of value. Whereas in fungibility, the substitution can occur with anything identical in worth, quality, form, or function.

Fiat money trade is one of the best examples of fungibility as the value of a currency remains the same everywhere. Also, it does not matter what denomination it is, which series it belongs to, or where it comes from as long as the value is equivalent to the other. It means a $10 bill will have the same value in every bank or every transaction made, irrespective of the series.

Another thing is that a banknote can be interchanged with multiple units as far as their values are equal. For example, it is possible to substitute a $10 bill with three $2 bills and four $1 bills. However, no two regional currencies can be fungible due to differences in their values.

Precious metals are considered fungible, but there are exceptions. For example, an ounce of gold is equivalent to another ounce of gold as both are indistinguishable in form and value. Anything that makes them unique, such as being assigned serial numbers or identification marks, ends the possibility of these being fungible.

It is impossible to find two identical gems and precious stones. The substitution of a unit of a diamond for the same quantity of another diamond cannot occur. Why? It is because diamonds differ in their sizes, shapes, colors, quality, and grades. Hence, their forms are not identical in any manner. Therefore, a diamond cannot be considered fungible.

Financial instruments like bonds, stocks, and futures contracts are fungible as they can be traded or substituted with equal units of each other between two marketplaces or stock exchanges. It is because shareholders get equivalent ownership interest in the company. Also, specifications in the contract remain the same, and one clearinghouse manages the options trading.

Not every tradable instrument is fungible in the stock market. However, stocks that are eligible for substitution with their identical counterparts are cross-listed. These are securities trading on multiple marketplaces, including the domestic and foreign exchanges.

Much like fiat currency, cryptocurrency is fungible as its value remains the same anywhere in the world. However, incidents like hacking can alter their units or values and make them non-fungible.

Here are a few examples that will make understanding the fungibility definition easier:

Example #1

Millionaire Williams has an ample amount of gold. He thought of exchanging them for 400-oz of gold bars from the Federal Reserve Bank of New York because the value of gold bars is always more in the market. The best part is that he knew gold was fungible.

Unfortunately, his financial advisor Mark told him that gold bars under the bank custody are not considered fungible. The reason is that bars have purity marking that assessors inspect to ensure they are per the depositor's instructions. Also, the bank must return exact bars to the depositor upon withdrawal. That is why gold bars are non-fungible.

Example #2

Non-fungible tokens or NFTs are digital assets representing ownership of a virtual creation. Recently, the sale of these collectibles dropped drastically. This fall in prices is a complete reversal from the first quarter of 2021.

One of the main reasons that have affected the popularity and sale of NFTs is the legal leniency. Many artists and content creators have complained about online theft of their work. It gives rise to copyright issues against the art and original content. However, finding a solution to the problem can once again boost NFT sales.

Whether goods, assets, or commodities are fungible depends on the possibility of their interchange with different units of the same item without any effect. In other words, any noticeable difference in the quality of products of the same units affecting their value and utility will make them non-fungible.

Some examples of fungible assets that are interchangeable include common stock, packaged products, dollar bills, gold, etc. Automobiles, precious stones, gems, trading cards, and real estate are not interchangeable and considered non-fungible.

Let us consider the following scenarios to understand the difference between the two properties:

Scenario 1

Ralph lends Thomas $500 for a month. At the end of the tenure, the latter repays the former, but he divides the amount into multiple denominations. Thomas gives five $100 bills to Ralph to settle the payment. It did not make any difference to Ralph, as the repayment equaled $500 in value.

Scenario 2

Mary planned a long drive with friends, but she did not have her sedan. Therefore, she asked Wendy, her neighbor, for her car for the trip. After returning from the trip, Mary requested Wendy to exchange the vehicle for the same model owned by one of her friends. But Wendy disagreed because the product was not identical in any manner.

In scenario 1, the value of the money does not change no matter how fragmented the denominations were. Hence, money is fungible. In scenario 2, it was an automobile, which would not be the same given the number of times it was repaired or used, even if it belonged to the same model. Hence, the deal was unidentical and non-equivalent in all respect. Thus, the car is a non-fungible asset.

This has been a guide to fungibility and its definition. Here we discuss stocks, precious metals, money, and examples of fungibility, along with scenarios. You may also have a look at the following articles –

• Fiat Money
• Numismatics
• Paper Money