Bitcoin Core Developer: Ensuring Bitcoin Fungibility Is Developers’ Top Priority in 2017

David Vorick is a Bitcoin Core developer, former IBM software developer, and co-founder of the decentralized cloud storage platform Sia.

In the article, Vorick explains why ensuring fungibility is a top priority for Bitcoin developers as we head into 2017.

Interchangeability, in simple terms, means that the value of each product is the same and they can be replaced with each other.

Bitcoin’s fungibility means that all bitcoins have the same value, regardless of who owns them or what their history is — and fungibility is critical to the success of a decentralized network.

Why? To understand the importance of fungibility, we must analyze how Bitcoin’s current limited fungibility causes real problems for the market.

For example, it is common for exchanges and merchants to treat Bitcoin differently based on its owner or history. A common example is an exchange trying to limit or prevent stolen Bitcoin from circulating on their exchange, especially if it is known that the coins were stolen.

Other discrimination may extend to bitcoins associated with drugs, gambling and other social vices. However, it should be noted that even if the current owners of these coins are not involved in these bad or illegal activities, their bitcoins may be "discriminated" and treated differently.

In short: Bitcoins with a clean history (referred to as 'white coins' in this article) will be accepted everywhere, while Bitcoins with a dirty history (referred to as 'black coins' in this article) will only be accepted in places that do not perform strict background checks.

Fair trade?

The problem isn’t that merchants are rejecting bitcoins that have been linked to illicit activity, but that the impact is felt by everyone.

When a transaction is executed, the value of the black coins is lower than the value of the white coins. This means that everyone will want to know whether the bitcoins they receive when they make a transaction are black or white, because this affects the fairness of the transaction and whether they can use the coins or exchange them for cash through normal channels.

The only way to know if your bitcoins are white or black is to request a background check through a centralized service. It's like suddenly the value of your bitcoins is determined by a centralized authority (which you might think directly conflicts with Bitcoin's core value proposition).

Each platform that accepts Bitcoin may have different policies in place for determining whether a Bitcoin is clean. Exchanges in different regions (US, China, India, etc.) may also have different policies.

Then, those bitcoins with the highest value will become the ones accepted everywhere (which will only be a small fraction of all bitcoins available).

This means that it’s not enough to ask just one exchange to do a background check, you have to ask every major platform if they think your Bitcoin is clean.

If a platform deems your Bitcoins to be not clean, their decision will reduce the value of your Bitcoin holdings, regardless of whether you use them on the platform or not — your Bitcoins will not be tradeable with all users of that platform.

It's getting worse

In 2016, we saw an increasing number of attacks on Bitcoin’s fungibility.

For example, blockchain forensics startup Elliptic successfully raised $5 million in funding to identify illicit Bitcoin, while Bitcoin exchanges like Coinbase are becoming increasingly strict about accepting Bitcoin with history attached.

So, Bitcoin’s fungibility has been broken, though not badly enough that people would feel the need to consult a blacklist service before accepting Bitcoin.

As the problem gets worse, when it reaches a certain point, it will impact the entire Bitcoin ecosystem - consulting a blacklist service is to ask for permission to use Bitcoin.

This would mean that Bitcoin would become centralized.

Because all platforms in all jurisdictions could harm fungibility by choosing to treat Bitcoin differently, most fungibility improvements can be attributed to privacy.

The best way to protect fungibility is to ensure that there is no way to find differences between bitcoins, no matter what their history is.

Solution

There has been a lot of momentum towards Bitcoin fungibility in 2016, with many of these improvements likely to be available to the general public by 2017.

The following solutions can improve Bitcoin fungibility:

Lightning Network

Most bitcoin transactions are currently conducted on a permanent public ledger that can be thoroughly inspected by everyone.

The principle of the Lightning Network can change the current model, allowing people who have never met to trade without being recorded in the ledger - transactions are conducted off-chain through the Lightning Network.

The number of open source Lightning Network implementations was around 5 to 10 in 2016, including Lightning, Blockstream, and MIT.

Although the Lightning Network has yet to see mass implementation, there has been a lot of progress, with several implementations set to launch in 2017.

However, the main Lightning Network code is dependent on the activation of Segregated Witness to work. If Segregated Witness is activated successfully, you can try out the Lightning Network for yourself in 2017.

TumbleBit

In early 2016, TumbleBit released a technical white paper. The white paper states:

"Every transaction on TumbleBit is backed by Bitcoin. We can guarantee that Tumbler will not destroy anonymity, steal Bitcoin, or initiate payments privately to 'print money'. We guarantee that the security of TumbleBit is supported by real-world computing paradigms and random oracle models, using standard RSA encryption algorithms and elliptic curve digital signature algorithms (ECDSA). We have used TumbleBit to mix transactions from 800 users and proved that our off-chain payments can be completed in seconds."

This is a huge leap forward. However, TumbleBit is not available yet, but a command line release is expected in early 2017.

You can expect 2017 to be the year Bitcoin fully supports large-scale, anonymous, and secure transactions, which is really exciting.

Zcash

After a long wait, Zcash was finally released in October 2016. This cryptocurrency pursues a kind of complete fungibility.

The zkSnarks technology used by Zcash enables it to achieve true fungibility, with every coin being identical to every other coin. However, the problem is that only the latest computers are powerful enough to run Zcash transactions, and there is uncertainty that the cryptography will prevent further censorship.

Nonetheless, we are likely to see improvements in 2017, lowering the computational requirements and improving cryptographic protocols.

The technological advancements made by Zcash are a huge boon to the cryptocurrency ecosystem.

Monero

Monero is a cryptocurrency built around fungibility, and perhaps its greatest strength lies in its philosophy that fungibility is strongest when everyone is forced to use private transactions.

Monero is essentially a giant on-chain cryptocurrency mixer, where every coin is mixed. This is a huge advantage, because in the past people would only mix their coins when they had something to hide. (This means that if you assume that the coins are not innocent, then this is a reasonable assumption, because they are mixing innocent coins)

But for Monero, this assumption is not valid, as all transactions contain mixed coins. Due to this philosophy and a large number of users, Monero is perhaps the most fungible cryptocurrency in the entire ecosystem, even better than Zcash.

2016 saw a huge rise in the popularity of Monero (perhaps the most valuable privacy-focused cryptocurrency) and the creation of a new protocol, RingCT, which combines traditional Monero output mixing with the ability to hide transaction values.

In early 2017, Monero will implement a hard fork to introduce RingCT, further improving the cryptocurrency’s privacy and fungibility.

Coming soon

Privacy and fungibility elsewhere have made significant progress this year.

JoinMarket, which has been actively developed by multiple developers in 2016, is working to provide a decentralized service. In addition, the Mimblewimble protocol was also proposed this year, which allows historical transactions to be completely removed from the blockchain.

Significant progress has also been made in privacy-improving technologies, such as MAST and Schnorr signature aggregation technology.

Schnorr signature aggregation technology will purportedly allow multi-party signatures to appear as if they were a single signature, while MAST can make highly complex scripts appear as if they were simple scripts.

Client-side validation is an off-chain scaling technique that improves privacy and scalability by allowing both blockchain history and blockchain state to be pruned, showing only a small portion of information to those who need to see it.

These improvements all facilitate interchangeability and are all being actively researched or developed.

Therefore, it is fair to say that fungibility research is very active today, and it is likely that new and exciting fungibility technologies will emerge in 2017.