How Token Burning Works and Why It Matters
This guide offers details about token burning, how it works, how it controls supply, creates scarcity, and how it increases a token’s value.
In cryptocurrencies, token burning is a calculated method where tokens are purposefully destroyed to lower their supply. This strategy creates scarcity, increasing the value of the remaining tokens.
Token burning helps build investor confidence and stabilize the token economy. This guide will describe token burning, its purposes, and its effects on a token’s price, especially when making cross-border transactions.
What is Token Burning?
Burning crypto tokens removes them from circulation. This is done by moving coin tokens to a unique wallet called “Burn Address,” which doesn’t allow anyone to retrieve them.
These classes’ cryptocurrencies are irretrievably lost. Token burning reduces a cryptocurrency’s overall supply, increasing scarcity and potentially increasing the value of the remaining tokens.
This is analogous to how limited-edition objects or collectibles gain value as they become more difficult to obtain.
How Does It Work?
Burning tokens is a simple procedure and entails a few steps.
- The decision to Burn
First, the control entity or the token’s management team decides whether to burn the tokens. This could be part of a long-term plan to manage the token’s supply, a reaction to market conditions, or even feedback from the community.
- Identifying Tokens to Burn
After the decision, the team determines how many tokens will be burned. This could be a fixed number or some portion of the total supply. Some projects run this semi-automatically, while others do it through smart contracts.
- Sending Tokens to a Burn Address
When transferring tokens to be burned, a special address, called a burn address, is used. It is a unique wallet that does not have the function to send tokens but only receives them.
Once the tokens are transferred to the burn address, they are lost completely. The transaction is recorded on the blockchain, and anybody can verify its validity.
- Verification on Blockchain
Once tokens are destroyed, they are removed from circulation since the blockchain records the transaction. This feature helps build trust and establishes that the burn is real.
Why Do Cryptocurrency Projects Burn Tokens?
The key motivation for burning tokens is to decrease the total coin supply and increase the remaining tokens’ valuation. However, there are other key reasons why projects use token burning.
- Building Investor Confidence
Regular token burning can boost investor confidence since they would notice that the value of their holdings has increased. When a firm burns its tokens on a predefined schedule, it is evidence that it has a plan to maintain the token’s circulating supply.
This can be comforting for investors who fear inflation or dilution of the tokens.
- Solving Hardware Issues
Sometimes, a token might be issued in error, especially when there is an error within the smart contract. When that happens, burning the surplus tokens can solve the situation and ensure that the surplus does not adversely affect the token’s value.
- Maintaining Stablecoins’ Peg
Tether is one stablecoin issuer that employs token burning to sustain its stablecoin’s (USDT) 1:1 peg with the underlying US dollar.
- Protecting The Network
Some blockchains encode small percentages of each transaction fee into a burning mechanism. This mechanism also protects the network against spam transactions and ensures its safety.
Types of Token Burning Methods
Token burning can be accomplished in many ways in any cryptocurrency project. Here are some common strategies.
- Token Buy Back
Some firms periodically buy back and burn some of their tokens. For instance, Binance sacrifices some of its BNB tokens every quarter based on the volume generated on its exchange. Thus, there’s a balance in the token’s depletion.
- Transaction-Based Burns
Meanwhile, a few projects burn tokens during every network transaction. Ripple is an example; it burns most transaction fees to reduce the overall supply of XRP tokens in circulation.
- Burning for Proof-of-Burn
Unlike most blockchains, proof-of-burn (PoB) utilizes a mining mechanism where miners burn their tokens to obtain new blocks. This process helps minimize the time and energy needed for mining.
- Community-Driven Burns
Most crypto projects allow community voting, where holders decide how and when the tokens should be burned. Thus, members have a say in the community’s governance and the token’s supply circulation.
Token Burning vs. Minting
Minting and burning tokens impact their supply. Minting increases the number of tokens in circulation while burning reduces them.
However, new tokens are often created for rewards, staking, and other specific purposes. Nevertheless, an equilibrium between these two processes is vital to the token’s economy.
Wrap Up
Token burns are the most efficient tool for maintaining the supply of cryptocurrencies. Fewer tokens are in supply, creating scarcity and increasing the token’s value.
In addition, the token burn process helps maintain the network’s stability, rectify mistakes, and enhance investor confidence in the crypto project. As more projects implement this circulating supply control, they will realize its usefulness.
