Token burns are an increasingly popular topic of discussion among experienced cryptocurrency investors and traders. But despite this, few people actually know the purpose behind a practice that permanently destroys otherwise valuable coins and tokens for the good of the network.
Here, we demystify one of the fundamental building blocks of controlled supply, helping you understand its role in cryptocurrency utility, value, and desirability.
What Are Token Burns?
In brief, token burns are essentially the process of reducing the total supply of a cryptocurrency asset by either temporarily or permanently removing coins or tokens from circulation. The process is generally used by smaller or less well-established cryptocurrencies to provide incentives for asset holders and encourage value growth.
This mechanism is unique to cryptocurrencies, since only distributed ledgers provide the technology necessary to permanently remove units of value from existence without any shadow of a doubt. This is often achieved by calling to a burn function that is coded into the underlying protocol or blockchain that is involved in cryptocurrency issuance.
Once particular conditions are met, the burn function can be used to burn a fixed number of tokens. The code that executes the burn function would then update the total supply of the asset, ensuring that the burn is a matter of public record.
For blockchains that lack a burn function, the circulating supply can be reduced by sending tokens or coins to a “burn address”, which is essentially an address that has no owner and nobody knows the private key—for example, the 0x0 address on Ethereum. These coins are not destroyed per se, but they can no longer be accessed, essentially serving the same purpose as a coin burn.
Although the burn function can typically be accessed by anybody with tokens or coins to burn, the function is most commonly used by the company or individuals managing the project.
Despite being a relatively new practice, token burn practices have already been implemented by some of the most prominent blockchain projects.
Perhaps one of the best-known cases is Binance’s quarterly token burn, which sees the world’s largest cryptocurrency spot exchange buy back and burn tens of millions of dollars worth of Binance Coins (BNB) from the open market each quarter using a fraction of its trading fee profits. So far, more than 10% of the total BNB supply has been burnt, while the token has exploded in value since its inception.
On the other hand, NewsCrypto—one of the most popular new platforms for budding cryptocurrency traders—has introduced its own unique take on the token burn mechanic. The platform offers several premium plans which unlock additional tools designed to help users maximize their profits, but these can only be purchased in NewsCrypto coins (NWC).
The platform then burns 20% of these, permanently removing them from the supply, while demand for tokens continues to grow in line with the platform. Thus far, this system has helped NWC climb by more than 27% since the start of the year—no small feat, given the fact that many cryptocurrencies have struggled this year.
Why Burn Tokens?
For the most part, token burns are used to ensure the total supply of a cryptocurrency remains deflationary—which essentially means the total available coins or tokens in circulation reduces over time. This system acts to increase the scarcity of the asset, which when combined with steady or increasing demand, should also lead to increased value due to the nature of supply and demand.
On the other hand, some companies, like those that operate the stablecoins Tether (USDT) and USD Coin (USDC) instead burn cryptocurrencies to ensure the circulating supply remains at parity with their fiat reserves. Whenever these reserves are topped up or reduce, then new coins need to be minted or burned respectively.
Token burns are also used by some projects as a type of error correction process. Back in 2017, Stellar, a popular blockchain used for cross-border value transfers, suffered from an inflation exploit that resulted in 2.25 billion new lumen coins (XLM)—thereby increasing the total supply of XLM by more than 5% at the time.
To rectify this, the Stellar Foundation burned an equivalent number of tokens, thereby bringing the circulating supply down back to where it should be. Stellar then went on to again burn a further 55 million XLM to cleave the total supply by half in a further move to reduce the availability of XLM.
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