Bitcoin is Not Fungible

Whether it's fine art, real estate, stocks, or Bitcoin, if a previous owner has engaged in criminal activity then your assets are at risk.

VC Sues Christie's

Consider a recent article in the Financial Times.

A wealthy art collector is suing Christie's after the auction house allegedly failed to tell him a Picasso painting he bought had been owned by an individual convicted of a serious drug offence.

It's a real Picasso worth £14.5M that was bought in 2023 by a VC firm. Unbeknown to them, the seller was a convicted drug trafficker and the painting was conceivably purchased using the proceeds of crime. These offences could easily be confirmed by a simple internet search, and so the VC took legal action against the auction house. Christie's fought back, saying they had complied with all legal requirements, including a duty of confidentiality to the client.

Worryingly for the VC, the legal system “tends to be quite stacked against a buyer” accordingly to a specialist lawyer. The case continues…

Learnings

What can we learn from the example in the fine art world? Here are the facts.

• You can buy an asset from a well-known vendor in the US
• The asset is authentic and was priced correctly
• You are a well-known and respected buyer
• You didn't know the identity of every previous owner
• A quick internet search would have revealed the asset is likely to be bought by the proceeds of crime by a previous owner
• You have no legal recourse against the vendor
• Your asset is now worth significantly less

The above scenario is not restricted to the fine art market. The same would be true if the asset was a car, a house, stocks, cash or crypto.

Some assets are more fungible than others. If it were gold, you could melt it down and sell it on the open market and none would be any the wiser (although you could only get away with this in small amounts).

What About Crypto

Crypto represents a unique challenge as it's very common that a digital asset has a long history of globally distributed owners. Some blockchains like Monero have opted for an anonymous approach where it's not possible to link a new owner with an old owner, even if you want to! This has resulted in sweeping bans that severely limits their use as money.

On the other hand, Bitcoin has a pseudonymous privacy model, which means coins can be traced as they are traded on the ledger. There are well-enforced regulations such as the Travel Rule that requires you to disclose who you send you money to and receive your money from. This week I made a payment of 0.005 BTC (~$600) using Coinbase and was required to provide the recipient's details.

Many major institutional Bitcoin holders carefully review the coins the buy and reject a large proportion if their coin history can't be determined a few hops back. Bitcoin funds are particularly cautious as they sell exposure to Bitcoin on behalf of their users, and so have significant holdings themselves that must be free from criminal activity.

Many funds even explicitly advertise their Bitcoin holdings so anyone is free to check the coin history. See Bitwise's proof of holdings, for example.

Does This Mean Bitcoin is Not Fungible?

Yes. Clearly this means that a Bitcoin that was bought by the proceeds of crime is worth less than a Bitcoin that wasn't. This is a legal definition of fungibility.

But also, No. On the ledger, according to the code, the two Bitcoins are interchangeable and can be combined with each other. This is a technical definition of fungibility.

What is true of Bitcoin is usually also true of gold. Gold is clearly fungible in the extreme. Two gold bars can be melted down and become indistinguishable from one-another at the molecular level. This doesn't mean that one gold bar can't be worth less than the other. If it is distinguishable by a serial number, and has a colourful history related to crime, then it is worth less.

It's possible to reverse the decline in value due to the association with crime. This happens when an authority stamps the asset as ready for legitimate resale on the open market. This happens with a police auction of stolen goods, when confiscated Bitcoin is resold. This is happening right now by the UK police.

Solution for Bitcoin (and Gold): Buy Freshly Mined Assets

Some coins are newer than others and this means they typically have a shorter coin history. A freshly mined coin today will have no history. It will be minted directly by the miner who will hold it until it is sold to the first owner.

By purchasing freshly minted coins, investors can have peace of mind that their coins will not be seized or otherwise devalued as the proceeds of crime.

For gold, a great scheme already exists called Fairmined gold. Once a mine is certified to pass environmental and ethical standards, their gold trades at 2–4% premium on the open market.

At Bitroots we specialist in giving access to freshly minted coins that are directly traced to the facility where they were produced. Contact us to find out more.