An In-Depth Explanation of Fungible vs. Non-Fungible

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Today, tokens are classified into two broad categories - fungible and non-fungible. Bitcoin


You've seen and have been astounded at the prospect of cryptocurrencies; with how everything's going right now, it won't be a surprise to see crypto establish itself as a mainstream currency in the next few years.

But while most people are acquainted with Bitcoin and Ethereum, they're just part of a much bigger ecosystem that operates within blockchain technology. "Exciting" is an understatement when we're to describe the prospect of blockchain affecting our lives in the foreseeable future. We're looking at storing critical data and information of real-world assets into a private and more secure place.

Imagine things like a complete medical record of a person being stored on the blockchain. It can also be an academic report or even a legal document with lots of sensitive information that can be stored securely where it cannot be tampered with. The possibilities are endless with how we're going to put blockchain technology into good use.

But if you think that cryptocurrencies are at the forefront of this blockchain revolution, then you're mistaken. Yes, the likes of Bitcoin and Ethereum will certainly have a huge part in it, but their impact is just one of the bigger things coming towards the blockchain world. But they're not alone.

Tokens rule the crypto world. Today, tokens are classified into two broad categories - fungible and non-fungible. Bitcoin and Ethereum are examples of fungible assets, while anything classified as non-fungible in the perspective of the crypto-verse is called a "non-fungible token" or NFT.

A token represents anything with value. Unlike traditional currencies and physical products, it is unrestricted in its ecosystem. It means it can have several roles and uses, and even similar tokens can have various purposes.

Fungible Versus Non-Fungible Qualities

Fungibility is a characteristic of money or other assets that can be interchangeable with other units of the same type. Fungible items are easily exchanged or substituted for another. Mature assets like cash will usually be fungible since it's not linked to one source, and hence, you can't trace where it came from.

It is not the same with non-fungible items, which are unique in every way. There's no replacement for these types of assets since there's only one available in the market - making them rare and very difficult to find. The lack of fungibility means that each item is usually linked to a specific origin, identity, and history.

Because of blockchain technology and Ethereum's ERC721 protocol, we're now seeing cryptocurrency tokens that differ from the usual "transfer one token to another person" characteristic of cryptocurrencies like Bitcoin. Non-fungible tokens are usually used when handling unique goods, property, and collectibles.

How Tokens Work

As previously mentioned, tokens are classified into two categories:

  • Fungible tokens (most cryptocurrencies today)
  • Non-fungible tokens (tokens that can't be exchanged or substituted for another)

Fungible Tokens

True to their name, these types of tokens work like any other traditional currency. They're easily interchangeable, can be transferred to other people, and are generally divisible. For example, one Ether is the same as another Ether since it's fungible. You can send ten units of ETH to someone over the blockchain, and they will receive ten units of Ether in return.

All fungible tokens share these qualities:

  • Uniform
  • Divisible
  • Interchangeable

Uniform - Uniformity means that each token is the same as the next (same value, same properties, and same structure). Tokens also have some qualities of money since they can be combined or split into smaller units.  A good example is Bitcoin, which can be split into smaller units called "satoshis."

Divisible - This means that a token can be split into smaller units. BTC has eight decimal points, which means it can be divided into 100,000,000 satoshis. ETH also has 18 decimal points.

Interchangeable - Fungible tokens are interchangeable in the sense that they're not linked to one specific source. They're also traded on cryptocurrency exchanges and marketplaces.  

Non-Fungible Tokens

These tokens cannot be replaced with another unit of the same type. NFTs like Cryptokitties are examples of ERC721 tokens (token standard on Ethereum for Non-Fungible Tokens) since each one is unique and different from one another. One unit can't be exchanged for a new unit since it's not the same kind.

All non-fungible tokens share these qualities:

  • Unique
  • Non-Divisible
  • Non-Interchangeable

Unique - Since these tokens are unique, you can only have one of the same. For example, each Cryptokitty is uniquely different from all other Cryptokitties - making them rare and difficult to find. A digital artwork sold as an NFT doesn't have any replacement since it's linked to its source and history stored in the blockchain.

Non-Divisible - These tokens can't be divided or transferred to smaller units. Since each token represents one unit only, they cannot be split into smaller parts. So, it isn't like Bitcoin that can be broken down into smaller units (satoshis).

Non-Interchangeable - Since NFTs are unique and not interchangeable, you can't trade them with someone else - nor transfer them to a different user. Once a buyer purchases an NFT, it cannot be changed or replaced with another - since each one is unique and linked to its source.

Ethereum Token Standards

Another way of differentiating fungible and non-fungible tokens is understanding how transactions are carried out within the Ethereum blockchain. Although Ethereum is a fungible token like Bitcoin, its blockchain supports NFTs. It's why we're using the Ethereum Token Standards to distinguish fungible and non-fungible tokens because the platform is open for both.

The set of rules that govern token transactions are referred to as ERC or Ethereum Request for Comment. Fungible tokens use ERC-20, while NFTs use ERC-721.

ERC-20

ERC-20 is a token standard for fungible tokens on the Ethereum blockchain. Since each Ether is interchangeable, ERC-20 reflects that trait by allowing other platforms to integrate it as a payment method easily. These tokens have the same properties and behaviours as other cryptocurrencies because they follow strict standards - making them uniform and predictable.

Since all fungible tokens are the same, they abide by certain standards. For example, ERC-20 tokens have properties that include how it's transferred and stored. The tokens follow a standard interface as well as a basic functionality to send and receive transactions.

ERC-721

Since NFTs are unique, each one must follow an independent protocol - which is ERC-721. NFTs use this token standard because each has a different source or history that affects its value and price.  These tokens can be sold and traded on the Ethereum blockchain - which makes them interchangeable.

ERC-721 provides a set of requirements for NFTs, including properties and functions to transfer or receive these assets. ERC-721 ensures that assets are tracked and maintained while ensuring that each unit is unique. It also ensures that each token contains unique metadata about its source and history.

So, ERC-721 tokens use the same network infrastructure as fungible tokens that use ERC-20. However, they follow different standards because of their unique properties and features - which makes them non-fungible. Moreover, while both NFTs and ERC-20 tokens are compatible on the Ethereum platform, each one has its own set of requirements and features - which makes it distinct from the other.

Conclusion

Fungible tokens and non-fungible tokens are different in a lot of ways. Whereas fungible tokens represent cryptocurrencies like Bitcoin, NFTs are unique - making their digital assets with different properties and functions. But if there's one thing that unites these two - it's the fact that they're likely to have a significant impact on financial institutions and the economy as a whole, sooner rather than later.

As long as the world continues to pivot towards digital technology, fungible and non-fungible tokens will afford a feasible solution for asset and property ownership and wealth accumulation.

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