$mrunal (Economy) Bitcoins Explained - Fungibility, Double Coincidence of Wants

7/9/2014
Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants
[Economy] Barter-Money-Bitcoin: Fungibility, Double coincidence of wants,

division of labour (Part 1)
1. Prologue
2. Bitcoins overview
3. Barter system
1. #1: Double coincidence of wants
2. #2: Division of Labour
3. #3: Divisibility of Value
4. #4: Fungibility
4. Bitcoin and Fungibility
5. Mock Questions
Prologue
Original plan was to write on Bitcoins. But for Bitcoin related MCQs, group
discussion (GD) and interview questions, one must know the basics of money itself.
Only then you can see how Bitcoin is better or worse than the money we use todayrupees, dollars or Euros. Hence a long series of articles.
1. In the first few of articles (total 3), well see why did people start using
traditional money (Rupee, dollar), how is it better than bartering system. And
how is bitcoin better or worse, on those parameters?
2. In the second batch of articles, well see evolution of money system: from
commodity money, metallic coins, fiduciary money, gold backed paper
currency, fiat money, bank money etc.-what were their advantages and
limitations. And how is bitcoin better or worse on those parameters.
3. And in the final articles, well see what is bitcoin exactly? from where does it
come? How does it operate? Advantages, limitations, future applications and
regulatory issues etc.
Bitcoins overview
Bitcoin is a digital code. (Some) people use it as currency.
Started in 2009 by Satoshi Nakomoto. He could be a man or a woman or a group
of people- real identity unknown.
There are two ways to get Bitcoins:
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#1: Mining
#2: Exchange
Aluminum is hidden inside

bauxite ore in earth.
Similarly, Bitcoins are
hidden in data blocks
If you dont want to mine bitcoins, then simply
designed by Satoshi and
find someone who has already mined bitcoins.
spread across the internet.
then
You can mine Bitcoins by
solving those datablocks
A. Offer him real money (rupee, dollar, euro)
using special computer
and get bitcoins in return. Websites that
softwares.
facilitate such transactions are called
Reward for solving one data
Bitcoin exchanges. OR
block=25 bitcoins at the
B. Sell him some goods/services, and earn
moment.
Bitcoins in return.
Total number of Bitcoins in
the system =~21 million.
Additional bitcoins cannot
be created beyond that.
Once youve have bitcoins (BTC), you can use them to buy goods/service (But
very few sellers accept bitcoins.)
OR you can just wait for the BTC vs.$ exchange rate to rise then sell your
bitcoins to a third party.
But what about anonymity and terrorist angle? what about money laundering? what
about inflation? isnt this a ponzi/MLM scheme? Well all those things in detail later
on. I gave the overview right now, because for next 5-6 articles, atleast ^this much
knowledge of bitcoin topic is required before we start comparing Bitcoin system with
barter system and money system. Now lets start first article.
Barter system
People have been trading with each other even before the advent of money, coin,
cash, currency, rupee, dollar, euro or Yuan.
They simply exchanged goods and services with each other through barter
system- 1 kg rice for a 200 gms tomatoes, 1 kg tomatoes for 50 gm almonds and
so on
Barter system: advantages

1. Simplest form of exchange. Had all nations did foreign trade on barter system,
there will be no headache of foreign exchange rates and associated problems.
Today if Dollar strengthens by some action of US federal reserves (=American
RBI), then it automatically becomes expensive for India to import oil from
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2.
3.
4.
5.
Saudi=>everything else transported through petrol/diesel becomes expensive=

inflation.
Less chances of overproduction, hoarding, profiteering etc. =less chances of
inflation. Although itll be wrong to say there will be no inflation in barter
system- because war, famine and natural disasters can create mismatch in supply
and demand even in a barter system => lead to inflation.
Difficult to concentrate wealth= Less inequality of income, and all the social
problems associated with it.
Barter system ensures need based production. In money system, firms create
products to create demand e.g. so many softdrinks and plastic bottles+ the
subsequent harm to health and environment.
Barter system promotes personal contact among individuals, social harmony, and
healthy community life, joint families etc.
But Bartering system had many limitations, thats why people shifted to the money
system. So,
What are the limitations of Barter System?
#1: Double coincidence of wants

I want you to cut my hairs just Amir Khan in Dhoom3. Ill give you 5 kilos
of rice
But I already have 200 kilos of rice from previous customers. I dont want
barber
rice anymore! Ill cut hairs only if you bring 1 kilo tomatoes as payment.
farmer
Another case
My son wants to get admission in your coaching class. I can give you 500
beer bottles as fees.
I dont drink at all! Although I do want new table and benches for my
Sir
classroom.
But I dont know any carpenter in this area, and even if I find one, there is no
Mallya
guarantee hell accept beer bottles as payment for making furniture!
Mallya
Thus, under barter system, the wants of two parties must coincide with each
other, otherwise they cannot trade with each other. This increases the transaction
cost as everyone will have to waste time and energy to find another party with
double coincidence of wants.
Money system solves this problem. Farmer can sell his rice for money, use that
money to get a haircut, and barber can use the same payment to buy tomatoes
from another farmer.
Money thus facilitates the exchange of goods and services, lessens the time and
effort required to carry on trade.
What about Bitcoins?

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Bitcoin also serves the same purpose but with some caveats
Fiat money
Bitcoins
Fiat money= money issued by the

government (or its central bank) example
Rupee, dollar, Yen, Yuan.
Bitcoins are not issued by

any government. Bitcoins
are unique pieces of
digital codes that (some)
people accept as digital
currency.
It is legally recognized money for settling

all payments and debts within the territory.
If you walk with a 5 rupee coin to a teavendor, he must serve tea, irrespective of
your race, religion, color, caste, age or
gender.
If he refuses to serve tea, hell be in legal
trouble.
An IT professional in
Banglore may accept
bitcoin payment for
creating software for
some American
businessman.
But if the same techie
offers to pay house rent in
bitcoins, the landlord is
legally free to refuse this
payment and can even
order him to vacate the
property.
Even better, you can get your rupees

exchanged in a foreign currency and import
any commodity from any part of the world
to India. So a fiat money (rupee) removes
the double coincidence of wants for the
trade within country and abroad.
Bitcoin removes the

double coincidence of
wants ONLY for the
people who believe in
bitcoin system, and not for
everybody everywhere.
Lets make comparison table:

FEATURES
BARTER
FIAT
MONEY
BITCOIN
trade can happen without double

coincidence of wants?
No
Yes
Yes, if two
parties agree.
#2: Division of Labour

In the barter system, buying/selling/trade can only happen, when two parties want
each others stuff- the double coincidence of wants e.g. farmer wants haircut
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and barber wants rice from that farmer.

But that doesnt always happen, so each household tries to produce all of its
daily requirements- from growing green tea, tomatoes, chilies in their backyard;
raising cows and poultry for milk and eggs; even making pickles, paper and
papad for entire year.
So is this good or bad?
Good from Gandhian principle of self-reliance.
Food inflation is kept in check- because everyone is growing vegetables in their
backyard.
But overall bad because:
Everyone is wasting their time and energy to become jack of all trades, instead
of becoming master of a single trade -medicine, engineering, construction,
accounting, teaching, singing, painting etc.
Thus, a bartering economy is less likely to produce specialists like Alexander
Graham Bell (telephone)=> Vin Serf (Internet)=> Sergey Brin (Google) because
everybody busy growing vegetables in their backyard and trying to become selfreliant-jack-of-all-trades.
And even if there are talented specialists, they wont have the necessary capital
or resources to continue their research. Imagine how many parties with Double
coincidence of wants youll need, for assembling the parts of a Large Hadron
Collider or a Param Supercomputer.
Money system also facilitates savings to become investment for the
entrepreneurs => more companies, more job, division of labor, optimal usage of
manpower, good for economic growth, R&D and international trade.
And with the money thus earned, anyone can buy his daily necessities, doesnt
need to grow vegetables or rear cows in the backyard.
What about Bitcoins?

Just like traditional money, Bitcoin also promotes division of labour, but it is limited
by the factor that not everyone accepts Bitcoins- especially the local milk-veggie
sellers. So if a software professional decides to live only on bitcoin, hell have to
start growing vegetables and wheat in the backyard of his house, arrange a goat/cow
for milk, and so on, we are back to square one- everyone trying to become jack of all
trades like in Barter system.
However, in future, Bitcoin may promote Division of labour to a whole new level
(when and if Bitcoin is accepted by a large population):
Imagine a laptop manufacturing company- owned and operated by an AI (or
robot) that accepts bitcoin payment, robots make and pack the laptops into
parcel, and drones deliver them at your door step.
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AI uses these bitcoins for paying the cost of raw material, warehouse rent,
electricity bill etc. to humans (or other AIs).
And whatever bitcoins left (=profit), are reinvested in buying more drones,
bigger servers and so on.
This is not possible in the present money system because legally- an AI or Robot
doesnt meet the KYC norms for opening a bank account = impossible for them to
pay electricity bills through netbanking or creditcard!
Anyways, lets update the table:
Features
barter
fiat money
(Rs./$)
trade can happen without double

coincidence of wants
No
yes
Promotes division of Labour?
No
Yes
Bitcoin
Only if both parties
agree.
Yes, lot possibilities
in future.
#3: Divisibility of Value
Under the barter system

JK
Rowling
Give me a cup of tea, Ill give you two pages from the latest Harry Potter
book.
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chaiwalla
I dont want just two pages, I want the whole book for my son!
Even if chai-walla continues serving tea to Ms. Rowling for 300-400 days, gets
all the pages of Harry Potter book and staples them together => still that stapled
book will not sell at the original value of a brand new Harry potter book (which
is say worth 30 kilos of rice).
Meaning:
You cannot always divide the value
You cannot always re-unite the divided values.
Other scenarios:
1. Jeweler wants a matchstick box. But its not possible to divide gold to such a
micro-micro-micro quantity where gold becomes proportional to the value of a
matchbox.
2. Mallya wants to buy a pencil box for his son, offers 1 table-spoon of liquor for 1
pencil box but stationary-walla will not accept because such low quantity of
alcohol cannot give the kick.
3. To pay for a cup of tea, Picasso cannot cutout 1 mm2 of canvass from his
original painting.
Fiat Money system (and Bitcoins) dont suffer from this problem of divisibility, and
hence facilitate the trade.
currency
Rupee (Rs.)
smallest unit
1 paisa=0.01 Rupee (that is 10-2)
Bitcoin (BTC) 1 Satoshi= 0.00000001 Bitcoin. (that is 10-8)

You can see it is possible to divide 1 BTC into so many small parts, so even if
new bitcoins are not created, it can continue as mode of payment by lowering the
corresponding values of commodities.
e.g. if today MRP of 1 laptop =1 bitcoin then in 2050, MRP of 1 laptop may
adjust itself to 0.00165 Bitcoins, if there is shortage of bitcoins.
And still you can pay 0.00165 BTC to someone by simply typing that specific
amount in your keyboard. Same thing is not possible with rupee or dollars
because of the chillar shortage in real life.
#4: Fungibility
Even if items are divisible, their fungibility is a problem under barter system.
Fungible items = those items whose individual units have same uniform value and
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mutually exchangeable, inter-changeable. For example:

1. The value of first five pages of harry potter book= Not same as the value of last
five pages of the same book. Because in the last pages you get the climax so
theyre more precious= not fungible.
2. Value of one diamond of 100 carat = not equal to ten smaller diamonds of 10
carat each. In this case, bigger the size, more precious. Even those 10 carat
diamonds are not mutually interchangeable because their individual value may
vary depending on cut,color and clarity.= not fungible.
3. If Picassos painting was cut into nine equal square parts, then Central Square
will be more precious than others. So you cannot interchange them. And if you
glue these torn parts together= its total value will be far less than the original
painting=not fungible.
4. Exception: Precious metal. Value of 1 kilo gold bar= Value of 100 gold coins
of 10 grams each. You can melt to reunite them, you can melt again to divide
them. And those 100 gold coins will be interchangeable because their individual
value will be same.= fungible.
But by and large, goods are not fungible and this creates obstacle in barter trade, when
two commodities are not available in their standard weight/size. For example, Suppose
the ongoing barter rate is 5 kilo salt = one live hen weighing 500gms.
A poultry farm owner wants to buy 2.5 kilo salt. He gives the whole live hen to
shopkeeper.
Common sense suggest that shopkeeper should give 2.5 kilo salt and cut half of
the hen and return it.
But which half? In non-veg cooking, the legs of chicken are considered more
valuable than its head and neck upper part. = dispute between customer and
shopkeeper.
Overall, the customers in a barter-trade will end up buying more than what they
really need. (e.g. 5 kilo salt even if he needs only 2.5 kilo.)= considerable
wastage and sub-optimal use of resources.
Money system solves this via fungibility.
Rs.1000 note= can be exchanged for 20 notes of Rs.50 each. And each of those
50 rupee notes have equal purchasing power. A 50 rupee note in your pocket will
buy as many ballpens, as the 50 rupee note in my pocket. (as long as ballpens are
of same brand-model.)
Similarly ten notes of Rs.100 can be exchange for a single note of Rs.1000 and
so on.
But there is an exception: Someone might offer 1000 rupees for a single 10
rupee note that has unique serial number like ABCD-123456789. but ignoring
such exception, currency notes are fungible.
So, if you give Rs.100 note to shopkeeper to purchase a ten rupee worth
ballpen=> hell give you 10 rupee pen + one note of 50 Rs. + four notes of
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10Rs.
Still Money system too has limitations:
You cannot pay Rs.149.75 through notes and coins because 25 paisa is out of
circulation. (Although possible if you pay via credit card, debit card or internet
banking)
Persistent shortage of chillar coins. And if you cut a ten rupee note into ten parts
using a scissors, itll not become ten 1Rs. notes.
Persistent looting by Shopping malls. Items priced @Rs.99, 499 or 999 often,
cashier wont give you one rupee coin back but instead gives a chocolate. (He is
making additional profit because for him cost price of 1 chocolate is less than
1 rupee.)
Bitcoin and Fungibility

Bitcoins (BTC) are fungible because
1. Individual units are identical. 1 BTC in Rajas Digital wallet will buy same
amount of goods & services as 1 BTC from Kalmadis digital wallet. (Even if
their unique digital codes are different.)
2. Mutual substitution possible. it doesnt increase or decrease the value. e.g. 100
centibitcoins (cBTC)= 1 bitcoin (BTC).
As such chillar/change problem doesnt arise in Bitcoin because you can pay exact
amount to the seller. E.g. if a pen valued at 0.4 BTC. you can type 0.4 in keyboard and
eletronically transfer that amount to seller. Its not like you have to give him 1
Bitcoin(BTC) and he gives 1 pen + 0.6 BTC in return. This is a digital transaction after
all.
But there is trouble brewing:
You may have read in newspapers that Bitcoin transactions are anonymous and
hence can be used by terrorists, druglords and tax evaders.
Therefore, some experts have came up with the idea of coin validation. Well
see about that in a separate article later, but for the moment the gist is:- Through
coin validation software, you can separate GOOD BITCOINS (those earned
through honest work) vs BAD BITCOINS (those earned through hacking &
other illegal activities) via analyzing their transaction history and origin.
This coin validation will destroy the fungibility of bitcoins. How?
Because then most users will refuse to accept bad bitcoins.
Some American users might even refuse to accept bitcoins originating from
people of Cuba, Pakistan, Afghanistan, North Korea or Iran-for the fear that later
US authorities may persecute/harass them while hunting for Bad Bitcoins/AlQaeda/Terrorists.
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Anyways lets update the table:

features
barter
trade can happen without

double coincidence of wants
No
Promotes division of Labour

Divisible?
Fungible?
Fiat money
(Rs./$)
Bitcoin
Yes, if both parties

agree.
Yes, but limited @the
Hardly yes
moment.
Yes and less
Not
Yes but limitation
limitations than fiat
always e.g. Rs.14.199
money
Not
Yes
Yes, for now.
always
Yes
In the next article, well see more on Barter vs Money vs Bitcoin, with reference to
storing wealth, account keeping, deferred payment, circular flow of income etc.
parameters. click me
Mock Questions
Assertion reasoning instructions: Each of the following questions contain a set of
Assertion (A) and Reasoning (R) statements. Answer codes are as following
A.
B.
C.
D.
Both A and R correct and R is the correct explanation for A

Both A and R correct but R is not the correct explanation for A
A is correct but R is wrong
A is wrong but R is correct
Questions:
1. (A) Money brings down the cost of transaction in trade, compared to barter
system. (R) Money promotes division of labour.
2. (A) A trader is free to refuse payment in Bitcoins. (R) Bitcoin is not a fiat
currency.
3. (A) A Barter economy is less likely to have to food inflation. (R) In Barter
system, trade can happen without double coincidence of wants.
MCQs
4. Correct Statement(s) about Bitcoins?
a. It is a digital fiat currency without fungibility.
b. It is not a fiat currency but has all the properties of a fiat currency.
c. Both A and B
d. Neither A nor B.
5. Find Incorrect Statement(s)
a. One fiat currency can be exchanged with other fiat currency.
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b. Bitcoin cannot exchanged with fiat currency.

c. Both A and B
d. Neither A nor B
6. Correct set of fungible pairs?
a. One i-phone of 64 GB capacity vs Four Nexus phones of 16GB capacity
each
b. 1 Bitcoin vs 108 Satoshis
c. 1 Rupee vs 100 cents
d. None of Above
Q7. Which of the following statement(s) is/are incorrect?
1. Bitcoin algorithm is designed to generate 21 million coins every year.
2. There are two types of Bitcoins: mined bitcoins and exchanged bitcoins, theyre
not fungible among themselves.
3. Smallest unit of Bitcoin is called Satoshi.
Choice
A.
B.
C.
D.
Only 1 and 2
Only 2 and 3
Only 1 and 3
All of them.
Q8. Which of the following is/are the benefit(s) of barter system over money
system?
1. Trade is possible without double coincidence of wants.
2. It promotes division of labour
3. Bartered commodities are always fungible.
Choice
A.
B.
C.
D.
Only 1 and 2
Only 2 and 3
Only 1 and 3
None of Them.
Q9. If a Barter economy is transformed into Money economy, what will be the
consequences?
1. Increased Economic Efficiency
2. Increased Transaction costs
3. Increased specialization among workers
Choice
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A.
B.
C.
D.
Only 1 and 2
Only 2 and 3
Only 1 and 3
All of them
For more on Economy, visit Mrunal.org/Economy
URL to article: http://mrunal.org/2013/12/economy-barter-money-bitcoinfungibility-double-coincidence-of-wants-division-of-labour-part-1.html

Posted By Mrunal On 24/12/2013 @ 21:27 In the category Economy
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Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

[Economy] Barter-Money-Bitcoin: Fungibility, Double coincidence of wants,

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

Aluminum is hidden inside

Barter system: advantages

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

Saudi=>everything else transported through petrol/diesel becomes expensive=

#1: Double coincidence of wants

What about Bitcoins?

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

Fiat money= money issued by the

Bitcoins are not issued by

It is legally recognized money for settling

Even better, you can get your rupees

Bitcoin removes the

Lets make comparison table:

trade can happen without double

#2: Division of Labour

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

and barber wants rice from that farmer.

What about Bitcoins?

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

trade can happen without double

Promotes division of Labour?

#3: Divisibility of Value

Under the barter system

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

Bitcoin (BTC) 1 Satoshi= 0.00000001 Bitcoin. (that is 10-8)

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

mutually exchangeable, inter-changeable. For example:

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

Bitcoin and Fungibility

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

Anyways lets update the table:

trade can happen without

Promotes division of Labour

Yes, if both parties

Both A and R correct and R is the correct explanation for A

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

b. Bitcoin cannot exchanged with fiat currency.

Mrunal Bitcoins Explained: Fungibility, Double Coincidence of Wants

For more on Economy, visit Mrunal.org/Economy

URL to article: http://mrunal.org/2013/12/economy-barter-money-bitcoinfungibility-double-coincidence-of-wants-division-of-labour-part-1.html

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