Token burning implies the permanent elimination of tokens from the supply in circulation. With burning, the tokens are removed from the supply forever.
The idea seems a bit strange: why would someone want to get rid of cryptocurrency forever?
Well, there are reasons for this, which we will explore in this article.
Token Burn Demystified: How It Alters Crypto Supply
The cryptocurrency market is big enough for tokens and the diversity of their value, so where does the need for token burning come from?
Burning tokens means that the supply becomes more limited, and because of that, the value and the price of cryptocurrency have a chance to increase.
The burning of tokens or coins is often a collective process that is encouraged by entrepreneurs of sorts. When a group of people is burning a small amount of crypto simultaneously, it affects the number of coins in the supply and can lead to coin value and price increase.
Ultimately, token burning is a means to maintain a balance between demand and supply. Even though the token burning itself does not influence the crypto price directly, it creates a “hype” surrounding the burning tokens and can potentially increase their price. With token burning, the value can be maintained or increased.
Many well-known cryptocurrencies practice token burning regularly. For example, Ethereum burns a portion of its tokens during transactions. The strategy that Ethereum implements results in a decrease in the number of coins in the supply chain, thus increasing the value of Ethereum-based tokens. However, the main goal was different: Ethereum wanted to transition from the PoW algorithm to the PoS, meaning that mining would not affect the network stability. The amount of Ethereum burnt now depends on the number of Ethereum transactions made. So, if fewer Ethereum transactions were made, more periodic Ethereum burns would be made.
Meme coins don’t lag on burning strategies. Shiba Inu coin has introduced the SHIB Burning Portal that allows to receive rewards for burning Shiba Inu coins. The burning of Shiba Inu coins is partly automatic and partly manual. An automatic mechanism is imprinted in the Shiba Inu’s own network called Shibarium. As with Ethereum, Shiba Inu’s automatic burning mechanism is linked to the number of coin transactions made.
Algorithmic stablecoins also turn to token burning to keep their price. In the case of algorithmic stablecoins, burning is turned to when the price is lower to match the demand. However, it’s shown that burning manipulations alone couldn’t influence the price of stablecoins.
With that said, burning tokens alone is not a guarantee of price inflation. Many other factors can influence the price of tokens, including the crypto project basics, the rating of tokens before the burning, the state of the market, etc. Token burning can indeed affect the prices of coins; however, there are many moving pieces when it comes to price volatility.
Understanding the Concept of Token Burn
So, what does it mean to burn tokens?
Burning tokens means sending tokens to a wallet called “burn address”, where it’s locked and, thus, removed from the cryptocurrency supply. Burn address is somewhat of a trash can for tokens, except that it cannot be accessed because there isn’t a built-in key. Once tokens or coins are sent to the burn address, nobody can recover or trade them (or perform other transactions), including the entity that’s sent them there. This wallet only accepts sending transactions.
The motivation behind token burning is primarily in value increase, as the price goes up whenever fewer coins are in the supply.
For example, algorithmic stablecoins can produce new tokens and then burn them to maintain their price in relation to fiat currency. This process is often automatic and is managed by the protocol itself.
The burning of tokens resembles a company buying some of its shares back. This way, the company can increase and, eventually, balance the value of the shares obtained by stakeholders.
Many crypto projects have regular burning events scheduled to ensure that the potential investor is confident that the token supply will continue to decrease to push them to invest in the token that’s worth to be stored as valuable.
Exploring the Motivations Behind Token Burning
Burning of tokens and coins can have various purposes and motivations. Here are some examples of why token burning can occur:
To increase value
Oftentimes, the primary motivation behind token burning is reducing the token amount in the supply and eventually increasing the demand. If the supply is low and the demand is high, the price tends to go up.
Value can also be increased due to publicity that the token burning creates. Awareness of the potential burn can increase the demand and, thus the price. There are many ways to support token burn publicly. For example, some crypto enthusiasts or influencers can announce their intention to burn some share of tokens; through it, attention to a specific cryptocurrency is raised, and some people might actually get inspired to invest in a token.
To reassure investors
Sometimes, the objective behind burning tokens is to reassure investors of the tokens’s ever-growing value. Stabilizing the prices within the supply chain can also be a goal that is still aimed at promoting confidence among investors. If the demand doesn’t go through fluctuations, the crypto prices tend to rise. Burning coins can ensure balance in the supply and some value stability.
To encourage Proof-of-Burn
Proof-of-burn is another consensus mechanism that verifies transactions. Such a mechanism promotes coin burning. Often, cryptocurrencies require burning before mining and adding new blocks to the blockchain.
Some blockchains use the proof-of-burn mechanism to reward miners and verify transactions. In such instances, miners are granted an invitation or permission to send crypto from the blockchain or other protocols to the burn wallet. After miners complete transactions, they are rewarded.
To achieve healthy network activity
The thing is, with every new token entering the supply chain, the mining speed decreases. When the token burning occurs, miners “have something to do” now – mine new tokens. The type of burning tokens and tokens that require mining don’t have to be the same in some instances. Therefore, the diversity of rewards can be accumulated here. All of this promotes healthy network activity.
Token Burn in the World of NFTs
NFT is a digital item that signifies ownership. Anything can become an NFT as long as it’s digital. NFTs exist in the blockchain as a record of ownership, a digital contract, if you will.
So, in the case of NFTs, when NFTs are burned, the ownership right is removed. It should be mentioned that burnt NFTs don’t cease to exist; there’s just no way to buy, sell, trade, or transfer an NFT once it’s burnt. The record of NFT existence will remain in the blockchain.
The process of NFT burning is very similar to token burning: it should be sent to the burn address.
There are different reasons for burning NFTs. When you compare cryptocurrency to NFT, crypto assets usually have a multiple supply of the same type of currency. But with NFT, every asset is unique, as it’s the very point of NFT’s philosophy. NFTs can belong to a collection, though.
So, when you burn an NFT, the value of the whole collection is likely to increase as the quantity of ownership related to a specific collection is reduced. From this standpoint, the price of NFT from a specific collection can increase.
Burning NFTs can also be done with the surface goal of gaining some publicity and the primary purpose of increasing the value of NFT.
Like cryptocurrency, burning NFTs can also support mining new NFTs to keep the network going. Plus, it gives NFT owners an additional level of exclusivity in their ownership.
Because NFTs are unique, they have an unpredictability touch to them. The thing is, not all NFTs are used for storing purposes; many are used as spams or scams. Obviously, the best way to handle receiving an NFT from an unknown user or with some demanding propositions (i.e., to download something before you open it) is to get rid of it – to burn it.
To sum up, burning NFTs or cryptocurrency is not a whim but a calculated move based on various reasons and motivations.