Token burning explained.
Token burning is the act of removing a specific cryptocurrency from circulation. This removal is permanent, and the coins will never be issued nor used again.
The practice of token burning is a straightforward process. The industry had also witnessed this act multiple times in the past. The creator of the token has the right to remove tokens from circulation for several reasons, particularly deflation. Bitcoin, Ethereun and other significant Blockchains, with their status right now, are unlikely to practice this mechanism. Often, token burning happens on altcoins and other smaller tokens, with a primary goal of controlling the number of tokens in circulation. This act, in turn, provides investors with greater incentives.
Token burning, however, is unlikely to be practiced with fiat currencies since regulations control their availability and flow. In some sense, token burning is the same as what publicly-owned companies do to reduce the amount of available stock. The process is known as “share buybacks.” Despite sounding like a ruthless approach, token burning serves a variety of purpose as well as different uses.
How is token burning accomplished?
While the concept sounds straightforward, there are different ways to perform token burning. After all, the goal is the same –to lessen the number of available tokens.
Burned tokens are not disintegrated; however, they cannot be used any further. Either the developer would repurchase the tokens in circulation or render them unavailable. To accomplish this task, there must be a public wallet with irretrievable functions where the developer can put the tokens’ signatures. It is also referred to as a perma-frozen “eater address.” All nodes can view the details. Furthermore, the coins’ status are displayed on the Blockchain.
As mentioned above, there are several ways to burn tokens. Most of the time, the chosen manner depends on the primary objective or purpose of the developer. Take, for instance, what happens in initial coin offerings. Upon completion of the ICOs, the unsold tokens must be removed out of circulation since they would be used as an incentive for participating parties. On the other hand, some developers periodically burn coins with a pre-set volume or interval. Binance, for example. The Malta-based crypto exchange had committed to burning 100M BNB tokens every quarter of the year. The coins’ volume varies depending on the total number of trades the platform sees every quarter.
Meanwhile, Ripple opts to burn tokens at every transaction gradually. XRP transacting parties who want to be prioritized in terms of execution can set fees. Instead of being returned to a central authority, these fees are being sent to an eater address upon clearance of transactions.
Tether, on the other hand, will mint tokens which are equivalent to the funds that would go as reserves. However, when the withdrawal takes place, the corresponding number of tokens to the amount extracted would be burn as well. In the end, no matter what method is used, burned tokens are completely useless.
What are the reasons behind token burning?
Regardless of the mechanism used, token burning is primarily done for deflationary purposes. Developers rely on this process to keep the stable value of the coins and to provide traders with incentives which would ultimately convince them to hang on to their coins.
Token holders are mostly the beneficiaries of token burning, no matter how it is carried out. By reducing the market supply, the value of the coins increases. The fewer the coins available on exchanges, the more valuable they get. It is the reason why crypto projects and developers set a limit in supply in the present and future times alike.
By relying on this finite faucet, crypto projects can enhance the value of the existing coins. They would also be able to create incentives for token holders and ultimately gain ongoing support. According to some accounts, this objective is the main reason why Binance burn tokens periodically.
There are also instances when token burning is carried out to correct errors, just like what happened to Tether. Accidentally, the firm minted $5 billion worth of USDT. Tether had to burn the tokens to keep the coins’ 1:1 ratio to the US dollar.
Meanwhile, for security tokens, burning works in a similar way, such as corporation shares buyback. The coins in circulation can be purchased at considerable rates, and they would be immediately burned to increase the value of tokens held by investors. Furthermore, the investors can even profit if the tokens would be re-bought at market price.
Finally, some developers decide to burn tokens for security purposes. Spammed tokens are rendered unavailable.
Is token burning applicable for other purposes?
Yes, it is. While most projects turn to token burning to increase the coins’ value, other developers have discovered that this method can be used to append and verify Blockchain transactions.
Proof-of-burn is just one of the famous mechanisms that sprang out from token burning. This method is used by miners to acquire mining rights. Although most industry miners still prefer the proof-of-work system because of its association to Bitcoin, some argued that it is costly as it devours significant resources. The proof-of-burn aims to eliminate these issues by limiting the blocks verifiable to miners.
Burning of tokens can significantly lessen the total number of miners at a given time frame. It means there would be lower competitions, and the need for significant resources would be taken out of the picture as well. But what about large miners who can burn tokens with vast amounts? To avoid having a disproportionate capacity, most PoB implementations today set a decay rate whenever a large miner verifies a transaction.
PoB and PoS have similarities as well. Miners are required to lock up their assets before they can gain mining rights. However, unlike PoB, PoS miners who decide to stop mining have the options to take their coins.
Is token burning advantageous for token holders?
Token developers gain significant benefits from token burning, but so as the token holders.
At first glance, this mechanism looks advantageous only to the crypto projects and developers. However, this method provides both parties with their best interest. To top it all, burning of tokens can stabilize the value of a coin and save it from price inflation. With favorable rates and prices, token holders would feel more motivated to hold onto their assets while the ecosystem grows. Furthermore, this removal process also indicates that a crypto project is reliable, particularly those coins that are still in their infancy.
In terms of unsold tokens on initial coin offerings, token burning can provide investors with enhanced transparency. Although a company can sell and profit from undistributed tokens, they might be subjected to allegations which can attract the attention of lawmakers and regulators. Meanwhile, a project that promises to use the raised funds for business operations exhibit a deep commitment to their investors and mostly offer their tokens at a considerable price.