Token Fungibility and Subjectivity

The primary two standards for token creation in Ethereum smart contracts are ERC-20 and ERC-271, used for fungible and non-fungible token creation respectively. Standardizations are useful because they allow composability, meaning that in a smart contract one can easily call functions defined in other smart contracts. For example, this allows for one token created in a smart contract to be traded in a decentralized exchange created by other smart contracts. I argue here that economically speaking, the extent of fungibility embedded in any economic good is ultimately subjective, which implies that more objective aspects of the technological design of the good in question do not determine its fungibility, although they can certainly affect people’s subjective assessments.

Fungibility is the extent to which economic agents perceive different physical realities as interchangeable (which includes digital goods since these are just graphical renders of information bits). But since this characterization resides on agents' perception of realities, no economic good is intrinsically more fungible than another. Even more, no physical reality is intrinsically an economic good. Instead, the fungibility of a class of physical realities depends on whether the agent perceives these realities as potentially providing different services, or in other words, if the sources of utility from holding or consuming different units of this class of goods vary across units. Even more, the sole aggregation of physical realities to define a “class” done by any third party is ultimately somewhat arbitrary.

Let me now give some examples of this principle. First, think about what people usually think as the most fungible goods, monies. Why are these fungible? While coinage and printing technologies, or the equivalent spendability of all monetary units in any deposit contract play a role, in the end what matter are peoples' perceptions about these characteristics. For example, coins and bills offered could be considered as counterfeited or too worn, which depends on sellers' subjective assessments. As for bank deposits, without deposit insurance, the same monetary unit at different banks can be priced differently by different people, for instance due to different perceptions about the risk of default across people and banks.

As for more non-fungible economic goods, think first about a simple example of two persons buying underwear. While the first one only cares about softness, the second also cares about its color. Therefore, if they need to choose between two pieces with equal softness but different colors, only one of these persons is going to perceive these as non-fungible.

Are then different Bored Ape Yatch Club NFTs objectively less fungible compared to units of any ERC-20 token? As I argued, nothing stops each of these NFTs within a collection from being perceived as interchangeable. One could even try an experiment to prove the point: Deploy a smart contract with ERC-271 standards such that all collection units look exactly the same today, but that at some point in the future all of these change into different colors. Make two of these collections, run two auctions with different groups of potential buyers, and tell only one of them about this change-of-color feature. Then, if market prices are different only for the collection with informed buyers, this suggests that units become non-fungible only because buyers knew about this change of color, even if both collections were exactly the same and created by using an ERC-271 standard.

Mathias Jimenez
Mathias Jimenez
Ph.D. Candidate in Economics