Two things are fungible if they are indistinguishable in terms of value from each other. They are completely interchangeable, and mutually replaceable. Fungibility is a basic requirement for any currency. One dollar has the same value as another dollar, one euro can be substituted for another euro. While it’s possible that you could get attached to a certain dollar because it has a special scribble on it, that attachment technically makes the dollar worthless. Or it could be worth even more, depending on who did the scribbling. What monetary value does a dollar have if you’re not willing to part with it? Even if the monetary value is higher than the face value, it technically is no longer a dollar, but a collectors’ item. So, for a currency to have monetary value, it needs to be fungible.
Are bitcoins fungible?
No, not really. Each bitcoin has a history associated with it, a log of all previous transactions, that anyone can see on the public ledger (it’s not easy to understand, lots of hashes and codes, but it’s there if you want to take a look).
Since it’s very unlikely that any two histories are the same, this makes each bitcoin unique. And it’s possible that I really like the history behind my bitcoin, so I’m not willing to trade it for the less interesting history of your bitcoin. This means that the two bitcoins are technically not fungible.
Yet Bitcoin works as a currency, even though each bitcoin is different from the others. This is a very unusual property for a currency to have. And it can be used to make Bitcoin even more powerful.
When you scribble on a dollar bill, you are effectively adding additional information to that item. It is no longer just a dollar bill, it is a dollar bill with an additional message. We can do the same thing to bitcoins.
We can add to any bitcoin some additional information, or “metadata”, that helps it to function as something other than currency, such as a smart contract, or a time validation. This vastly increases Bitcoin’s value and broadens the technology into other fields. One of the most common ways of doing this is through coloured coins (more on these later), which add functionality while retaining all of Bitcoin’s advantages. The potential is colourful. (Sorry.)
(For more on how Bitcoin works, see Bitcoin Basics.)