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The Theory of Burning – Why is it crucial?

cryptoknowmics.com 19 May 2022 03:17, UTC
Reading time: ~3 m

If you follow cryptocurrencies, you've probably heard of coin burning. It is a method of reducing the supply of a coin. Coin burning became popular around 2017 and has been duplicated almost endlessly since then. It is now a common trend in the cryptocurrency industry. The phrase "coin burning" conjures up ideas of an investor setting fire to real money. Of course, this is not physically feasible because digital currencies are only present in virtual form. Token burning is when a coin's creators remove a particular amount of tokens from circulation. Burning tokens has several purposes, the most common of which is to minimize the market's inflationary pressures. It is like a public company repurchasing stock. Such companies use the cash available to acquire common equity shares, reducing the total outstanding shares. This strategy increases earnings per share by boosting the value of outstanding shares. The net profit to share ratio increases. Big blockchains like Bitcoin and Ethereum don't employ this methodology. On the other hand, altcoins and smaller tokens commonly burn to regulate the circulating supply, further drawing in investment.

But how do cryptocurrencies get burnt?

Token burning has many variations, but the ultimate goal is to reduce the total number of available tokens. While you can't burn Cryptocurrency, you can make it unusable. Token signatures are visible to all nodes but are permanently frozen, saved in an irretrievable public wallet called an "eater address." Blockchains publish the status of these currencies. Projects burn tokens in various ways, depending on their goals. Some will utilize a one-time burn mechanism to remove unsold tokens from circulation after their ICO (Initial Coin Offering). Others choose to burn coins at set intervals and volumes. Binance, for example, burns tokens quarterly to ensure its native BNB coins preserve their value. Ripple burns tokens with every transaction. The transaction fee is not refunded to any central authority when parties use XRP. Instead, they're sent to an eater's address once a transaction clears. Stablecoins like Tether (USDT) produce tokens when money is deposited and burn them when withdrawn. Regardless of the technique used, the outcome is the same: burned crypto tokens become useless and are, therefore, removed from the market.

What else?

Proof-of-Burn consensus (PoB) is a famous mechanism that evolved from token burning. It focuses on users burning their tokens to acquire mining rights. While Proof-of-Work (PoW) remains the most plausible approach, partly because of Bitcoin's support, PoW consumes a significant amount of resources and can be extremely expensive. PoB solves this problem by restricting the amount of blocks miners may verify to the number of coins they've burnt. On the surface, it forms a virtual mining field that may expand in size as more burning of tokens happens.

Is the price impacted?

There is no guarantee that the token's value will rise immediately after a burn occurs. Other information regarding the crypto token might sometimes overshadow its importance. Alternatively, investors may be aware that a token burn is imminent and "price it in" at an early stage. If you'd like to increase the value of an asset over the long run, burning tokens may be beneficial. Those staking tokens in a Proof-of-Stake protocol can also gain by burning them. Taking large quantities of tokens out of circulation may increase the value of stake rewards. Some programs incorporate burning events regularly. An essential part of the goal here is to convince investors that there is no inflation or over-dilution in the future supply of the token. As a result, the token's appeal as a "store of value" can be reinforced. Burning is an effective strategy for rebalancing an economy in general. On the other hand, it may not work with all Cryptocurrencies because some are best suited to serve as a medium of exchange, while others are better suited to serve as a store of value.

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