Token burning in crypto explained
You may have heard of token burning in the context of cryptocurrency and wondered what it is. Token burning is destroying tokens, often done to decrease the circulating supply.
While many in the ecosystem believe this method is innovative, an economist will tell you that similar concepts have been used for decades in the traditional economy.
What happens when a crypto token is burned?
Token burning is often done by sending tokens to a wallet that cannot be accessed. Once the tokens have been burned, they can no longer be used or traded. Not having access means no one has the private key for that wallet address. An example of a burn address (also called “eater address”) on Ethereum is 0x000000000000000000000000000000000000dead. It currently holds $220M worth of tokens from different cryptocurrencies that have sent their tokens to it.
One thing to validate is that the team doesn’t have the private key, as the burn is only accurate if the tokens are no longer accessible. If the tokens are burned to an account where they hold the private key, they can access the tokens at a later stage.
Why do cryptocurrencies burn tokens?
There are a few reasons why cryptocurrencies burn tokens. The first reason is to increase the value of the remaining tokens in circulation.
Depending on the token, it can have a limited or unlimited supply of tokens. The hypothesis is that the demand for the remaining tokens increases by destroying some of the tokens. This can also help to reduce inflationary pressure on the price of the token.
It’s important to understand that while the intent can be to increase the token price, the market can also react differently to what is expected. If so, the price can decrease. In the example above, the price will only increase if the market demand and supply are equal to or higher than what it was before the token burn.
Another reason why cryptocurrencies burn tokens is to indicate that the team behind the project is committed to its success. For example, when a team is burning tokens from its own treasury. Destroying tokens puts them out of reach and makes them unusable, which shows that the team is not interested in selling their own tokens for personal gain.
Is burning crypto a good thing?
Whether or not burning crypto is a good thing depends on your perspective. For those who hold the currency, it can be seen as good because it can increase the value of their investment. And if you’ve been investing and sitting on those tokens, and the market demand is the same as before the burn, the price per token will increase.
You can also argue that decreasing the supply makes it harder to get new investors on board. If the circulating supply is less and the price is higher, the roof for participating has also increased. If the goal is mass adoption, this can be unfavorable.
These different types of mechanisms all stem from economics. So it’s essential that the team behind the token fully understand each move’s benefits and disadvantages.
What are examples of coin burning?
Ethereum
In August 2021, Ethereum went through the London hard fork (EIP-1559). Before moving over to Proof of Stake. One of the improvements that came into play is a burning mechanism. Since then, over 2 million ether has been burned due to the burning process and is out of circulation.
Ethereum is burning more Ether (ETH) than what is being issued. When writing this, roughly ~688k Ether has burned annually, with 603K being issued yearly.
Binance
Binance Smart Chain, the blockchain of Binance, the crypto exchange, has two mechanisms. Quarterly burn and burn a portion of gas fees on each transaction. Both aim to reduce the total supply of Binance coins.
For the quarterly burn, the Binance team burns a given number of tokens. For the 21st quarterly BNB burn, the numbers were:
Total BNB burned: 2,065,152.42 BNB
Approximate value in USD: ~$574,800,583.92 USD
In this case, the team also shows proof of this by linking to the transaction hash on the chain.
Algorithmic stablecoins
Some algorithmic stablecoins use inflation and deflationary mechanisms to keep the price pegged to its intended value. These get triggered based on changes in supply or demand for the token.
After Terra’s collapse, these mechanisms’ viability has been questioned. Fairly so.
Bitcoin
The story of token burning on Bitcoin is not about a burning mechanism. Instead, it’s about people. Many people invested in Bitcoin early and experimented with buying or mining. However, we’ve all heard the stories of friends or people who have lost or forgotten where they had their Bitcoin.
As Bitcoin has a limited supply, people have involuntarily become burners. These are Bitcoins that, even though they are part of the total supply, never will see the light of day.
Glassnode says up to 10% of the token supply will not be found again. Others speculate it’s as high as ~25%.
What is proof of burn?
Proof of burn, in the context of token burning, is not what it sounds like. Proof of Burn (PoB) is a consensus algorithm. And is a proposed method to lower the energy consumption on Proof of Work blockchains. So nothing to do with tokens.
However, in token burning, proof of burn can often refer to making the transaction hash that shows that a token has been sent to a burner wallet public, so it’s easy to confirm.
Conclusion
Token burning in cryptocurrency refers to destroying tokens. This is done to increase the value of the remaining tokens in circulation and can also help to reduce inflationary pressure on the price of the token. Whether or not burning crypto is a good thing depends on your perspective. Overall, it seems like a positive move for existing token holders invested in the given cryptocurrency token.
