Crypto can be burned by companies, individuals, centralized crypto exchanges and decentralized platforms. Some crypto asset algorithms lock in destruction from the very beginning. Why do they do it?
Burning means taking funds out of circulation, which is something that happens outside the world of cryptocurrencies too. For example, central banks can limit the issuance of money and remove fiat currencies from circulation in order to reduce inflation rates – the less money, the more expensive it is. In the stock market, the practice of share buybacks – where companies repurchase their own assets – is commonly used to prevent share prices from falling.
Why burn tokens?
There are two key reasons why developers burn cryptocurrencies: to increase the value of the token in the future and to reduce price volatility. Crypto projects can burn a part of their incomes in order to create additional demand for a native token. A number of cryptocurrency exchanges have implemented programmes to withdraw their native tokens from circulation.
The most famous example of the systematic (quarterly) destruction of a cryptocurrency is the burning of BNB coins on the Binance cryptocurrency exchange. Every three months, the platform reduces the supply of its tokens by approximately USD 10 million, which allows Binance to maintain a high, stable price.
Token burns can either be arranged in advance or executed in response to a situation that has arisen. Crypto developers mathematically calculate the value of a coin, and if a certain amount needs to be withdrawn from circulation in order to stabilize its price, tokens will be burned. There are other reasons for burning tokens including, for example, fixing certain errors:
- when too many crypto assets have been issued;
- when an incorrect coin address is used;
- in case of an uncontrolled increase in the issuance of a crypto asset.
Cryptocurrency burning can serve as a tool to protect networks from spamming, where attackers stage a DDoS attack, creating lots of “empty” transactions with an increased commission. This case, some blockchains partially or completely burn transaction fees. For example, the Nominex cryptocurrency exchange does this with its internal NMX token. NMX token pools have transaction fees of 0.3%, while commissions in other pools are set at 0.1%. Once a day, the token commission held in NMX is burned. This commission burning mechanism is also implemented in Avalanche, Ripple and other crypto projects.
Another reason is maintaining balance in blockchain mining through the PoB (proof-of-burn) consensus algorithm. The essence of PoB is that by burning the crypto, the validator shows “loyalty” to the blockchain and a willingness to accept some short-term losses for the sake of long-term investments. Miners who burn some of their coins have the right to add a new block to the chain and receive a reward. The proof of the burn involves sending coins to a special “eater address”. The transaction is recorded in the blockchain, and the validator receives a reward. The more coins a user burns, the more chances they have to mine a new block.
PoB is something of an experiment, and the algorithm remains poorly understood. It is not clear, for example, how it will work with scalable networks. One of the better-known projects using proof-of-burn is Counterparty (XCP).
Finally, coins can be burned when an ICO is held. One project that did this is Neblio, which destroyed the tokens that weren’t picked up during the initial offering.
Who is burning which crypto assets?
Cryptocurrency project teams and token owners can take the decision to burn a part of their assets, or the procedure can be hardwired into the blockchain protocol. Binance Coin (BNB), Bitcoin Cash (BCH) and Stellar (XLM) were among the first projects to start burning tokens, reducing the market supply of the coins in order to achieve an increase in their value.
Tokens that are burned are taken from various sources:
- a part of the profits made by centralized and decentralized crypto exchanges;
- transaction commissions;
- coins belonging to validators (for blockchains that use the proof-of-burn consensus mechanism);
- wrapped tokens when they are unwrapped and converted back to the original coin (see our article on “What are wrapped tokens?”).
How tokens are burned
In most cases, tokens are burned by being sent to an address that no one else has access to. A crypto wallet for which there is no private key – i.e., nobody has access to it – is created for this purpose. The address of this wallet is known as a burn address or eater address. Anybody can use a blockchain explorer at any time to find out how many tokens have been sent to be “eaten”.
Special algorithms and smart contracts are used to burn tokens. For example, the Ethereum network has a burn function that allows you to burn ETH and other tokens with different standards.
How withdrawing coins from circulation affects crypto asset prices
Burning affects the value of cryptocurrencies in the short and long term in different ways. It all depends on the project goals and the algorithm for withdrawing coins from circulation. The cost of tokens does not directly depend on the burn procedure, though the balance of supply and demand is important. If the coin itself is of interest to investors, then a decrease in its supply on the crypto market will most likely lead to an increase in demand.
Sharp increases in the prices of assets can be observed in the immediate aftermath of a burn. A coin’s price can also rise in the long term, which is to say that burning can have an effect similar to foreign exchange intervention in fiat money markets (a one-time purchase/sale of a large amount of currency).
NFTs can also be burned
Yes, you can destroy these tokens too. Some projects have already outlined NFT burn mechanisms in their whitepapers – burn.art is one example. The native token of this platform – ASH – is minted by burning NFTs. The website’s users can burn their non-fungible tokens, receive ASH in exchange, and thereby potentially increase the value of other NFTs in their collections.
Conclusion
Many crypto projects burn tokens, but the process shouldn’t be taken as a guarantee that the asset price will increase. The value of a cryptocurrency is affected by many other factors.
Projects seeking long-term development generally take a careful and considered approach to burning coins.