Token Burning Explained In 5 Minutes
Proof of Burn
Token Burning Mechanism refers to the practice of removing existing tokens or coins from circulation. Miners and developers burn tokens by sending them to a wallet address without private keys. Private keys are required to gain access to digital assets and have the ability to spend them whenever one wishes to.
Reasons for Coin Burning
There are many reasons why projects engage in coin burning, but it is mainly done for deflationary purposes. It is believed that deflationary cryptocurrencies gain more value when some of their coins are removed from circulation.
This is in contrast to fiat currencies whose circulation supply is increased through the printing of more notes and coins in a process known as quantitative easing. This causes inflation and reduces the buying power of fiat currencies.
Some crypto projects avoid the dilution of a token's value by burning the coin. The leading digital currency, bitcoin, does not burn its tokens but has a limit to the number of coins that will ever be mined. Every four years, the number of coins produced per day is cut in half, making Bitcoin a deflationary asset.
This partly explains why the value of Bitcoin usually increases after a halving event. Ethereum's EIP-1559 upgrade will introduce a cryptocurrency burning mechanism to the protocol, and make Ether deflationary.
Security tokens can be burned for different reasons. Investors in security tokens are entitled to dividends from the projects. Burning the tokens is similar to the buyback of shares by publicly traded companies. The process increases the value of the tokens held by investors.
In some other cases, cryptocurrency burning is done to prevent distributed denial of service (DDoS) attacks.
Coin or Token Burning: How it Works
Coin Burning comes down to removing tokens from circulation. There are different ways in which this is done.
Some projects do a one-time burn at the end of their initial coin offering (ICO). This is mostly done to remove the unsold tokens from circulation. This incentivizes early participants of the ICO.
Other projects burn a fixed number of tokens at periodic intervals. For example, a project can be a set number of tokens every 3 or 6 months until a target number of tokens is completely removed from circulation.
Cryptocurrencies such as Ripple are burned with each transaction.
Stablecoins and wrapped tokens are burned when an equivalent amount (fiat or crypto) is withdrawn from reserves.
Cryptocurrency Burning Examples
Safemoon is one of the projects that recently grabbed headlines when its prices surged higher. About 1 quadrillion Safemoon tokens were created but by launch time, 777 trillion tokens were available.
The project burned 223 trillion tokens.
Safemars is another project that is burning its tokens to reduce the supply. More than half - 53% - of the total supply was destroyed following a community vote. This means only 47% of the tokens will be in circulation.
When a project has a large supply, the price tends to be very low. Decreasing the supply has the chance of boosting the token price. Though it is not always the case, there is an inverse correlation between token supply and price.
Who Benefits from Token Burning?
Destroying tokens is meant to benefit both investors and developers. This is because it is designed to curb inflation and maintain the token price stable. Price stability gives investors confidence to hold tokens and not dump them on the market.
Many projects prefer to burn unsold tokens after the ICO to provide greater transparency to investors. Listing unsold ICO tokens on exchanges could lead investors to allege that the project is only after its own interests by accumulating profits.
Token Burning is done for different reasons and from investors'perspective, its main job is to increase the value of the token. Developers may see it as a way of increasing transparency and security on the network.
Either way, what is important is that stakeholders are happy. Users can buy, sell, trade and hold tokens - that have implemented coin burning mechanisms - such as Safemoon and Safemars on BitForex Cryptocurrency Exchange.