Tokens burning - what is it and what is it for?

3 min reading

The burning of tokens involves the permanent removal of existing cryptocurrency coins from circulation. The practice of burning is quite common in the industry and is very simple. Token burning is a deliberate action taken by the creators in order to remove a certain number of available tokens from circulation.

token burning

There are several reasons why tokens are burned. This is usually done in order to cause deflation. Larger blockchains such as Bitcoin and Ethereum do not need to use this mechanism. However, burning is often used by altcoins and smaller exchanges to control the number of tokens in circulation. This provides greater benefits to potential investors.

The burning mechanism is unique to cryptocurrenciess, since regular fiduciary currencies are usually not literally "burned". However, the supply of traditional currency is regulated in a different way. The burning of tokens is extremely similar to the buy-back of shares by public companies, which reduces the amount of available shares in circulation. The burning of tokens has several unique uses and serves different purposes. What purpose? You will find out from this article!

What does the tokens burning process look like?

The burning concept is simple, but you can achieve it in different ways. The goal is to reduce the existing number of tokens available. This sounds specific, but burning tokens does not literally destroy them, but makes them impossible to use in the future.

The process involves the redemption or withdrawal of the available currency by the project developers, and then their removal from circulation. To this end, token signatures are placed in a special public wallet known as the "eater address", which is visible to all nodes but is permanently blocked. The status of the tokens contained in it is published on blockchain.

There are different ways of burning tokens and they vary depending on the purpose of the process. Some will use a one-off burn after the end of the ICO (initial coin offer) to remove unsold tokens from circulation. Others prefer to burn coins periodically at fixed or variable intervals. 

Binance, for example, burns tokens quarterly as part of the commitment to reach 100 million BNB tokens burned. The number of tokens varies according to the number of transactions carried out on the platform each quarter. 

The Tether, on the other hand, creates tokens when the funds are deposited into reserves and burns the equivalent amount at the time of collection or withdrawal. Regardless of the mechanism, the result is the same: the burnt tokens become useless and effectively eliminated from circulation.

Reasons for burning tokens

What really makes it necessary to burn cryptocurrencies? There are many interesting reasons that are simply worthwhile:

An effective consensus mechanism

This applies to coins that adopt Proof-of-Burn (POB) as a consensus mechanism. The POB is a unique way to achieve consensus in a distributed network. It requires users to burn part of the coins to achieve it.

Increasing the value of tokens

Demand is the central economic concept that gives value to a specific asset, in this case cryptocurrency. Unlike fiduciary currencies, cryptocurrencies are deflationary. This means that the supply of coins for most cryptocurrencies is constant, without creating additional coins once the total supply is reached. The best example is bitcoin, which has a constant supply of 21 million. If demand increases, prices will also increase, as there are a limited number of bitcoins in circulation. Likewise, if the supply of bitcoins continues to fall because of burning, lost private keys or forgotten bitcoins, for example, then prices would rise. The burning of tokens reduces the total supply in circulation because they are deliberately destroyed. This is an effective method of increasing and stabilizing the price of tokens. The economic rules clearly state that reducing the quantity in the market makes a good more valuable!

Protection against spam

Coin burning works as a natural security mechanism against DDOS (Distributed Denial of Service Attack) and prevents spam from blocking the network. In the same way, users pay a small amount of money for sending bitcoins (BTC) or give away Ethernet in exchange for smart contract calculations in blockchain Ethereum. Cryptcurrencies burning generates a transaction execution cost. Instead of paying users to verify the transaction, some projects have integrated a mechanism where part of the sent amount is automatically burned. Ripple ( XRP) is a project using this economic model.