Key Takeaways
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Coin burning is the process of permanently removing a portion of a cryptocurrency's supply from circulation, and it offers cryptocurrency projects a way to manage supply.
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There are several reasons why crypto projects burn tokens, including proof-of-burn, increasing value, and price management.
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The advantages of burning tokens include curbing inflation and maintaining/increasing value. In contrast, the disadvantages include the permanent removal of assets and the need for large quantities to make a significant impact.
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Shiba Inu implemented coin-burning to increase scarcity and improve price stability of SHIB.
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After Ethereum implemented a fee-burning mechanism, more ETH is burned validating transactions than issuance, turning the cryptocurrency deflationary.
Maintaining an asset's price is one of the biggest challenges facing cryptocurrency projects. As a solution, some projects are engaging in "coin burn" to manage their cryptocurrency supply, which could involve developers buying back coins from the market and removing them from circulation, a community driven initiative to drive up the value of their holdings, or a developer upgrade that burns a portion of transaction fees. In all these cases, the burned tokens are permanently removed from the cryptocurrency's supply, and are inaccessible to anyone.
This article will delve into what coin burn means, how it works, why projects burn tokens, the pros and cons of burning tokens, and the impact of coin burn on two specific cryptocurrencies, SHIB and ETH.
What Does Burning Crypto Mean?
Burning crypto involves destroying a project's tokens or coins, by sending them to a burn address. The destroyed tokens are typically removed from circulation and cannot be used or traded in the future. There are different ways to burn tokens, depending on the project's technology and the community's decision.
How Does Token Burning Work?
Token burning typically involves a smart contract or protocol mechanism that identifies and removes a specific number of tokens from circulation. The tokens are sent to an address with no keys, meaning no one can access the tokens. The process ensures the tokens are permanently removed from circulation, as no one can access them.
There is also voluntary token burning, where holders take the initiative to send tokens to a burn address, permanently removing them from circulation. As an incentive to encourage users to burn tokens, some protocols offer users rewards, such as a share of transaction fees.
Why Do Crypto Projects Burn Tokens?
There are several reasons why crypto projects burn tokens. Some of these reasons include the following:
Proof-of-Burn
Proof-of-Burn (PoB) is a consensus mechanism where users "burn" their cryptocurrency to earn the right to create a new block. The burnt tokens prove the user's commitment to the network. This helps the network to maintain its security and prevent attacks, as burning tokens requires a financial cost that disincentivizes malicious behavior.
Increase Value
Burning tokens can increase the value of a cryptocurrency by decreasing the supply of tokens in circulation. Generally, when fewer tokens are in circulation and the demand remains the same, the price per token will likely increase. Coin burning is often used by crypto projects to boost market value and appeal to more investors.
Price Management
Burning tokens can also help manage the price of a cryptocurrency. If the supply of tokens is high and the demand is low, the cryptocurrency price will likely fall. For example, algorithmic stablecoins burn a certain amount of their tokens to decrease the supply and stabilize prices to prevent this from happening.
Algorithmic stablecoins are cryptocurrencies that maintain a stable price through preset rules or algorithms. One of the mechanisms that algorithmic stablecoins use to manage their prices is coin burning. When the price of the stablecoin is above the target price, it means there is an excess supply of the stablecoin in the market. To reduce the supply and bring the price back down to the target, the algorithmic stablecoin initiates a coin-burning mechanism.
The mechanism involves a smart contract that automatically purchases and burns a certain amount of the stablecoin from the market. By removing some coins from circulation, the supply decreases, which leads to an increase in the price of the stablecoin, and eventually, it stabilizes at the target price.
Pros of Burning Tokens
Coin burning has a deflationary effect, and can affect the price of a token by reducing the supply (and ideally increasing the value of the cryptocurrency).
Curbing Inflation
Burning tokens' most significant advantage is that it helps curb inflation. When there are more tokens in circulation, the value of the cryptocurrency can decrease due to the oversupply. Burning tokens remove a certain number of tokens from circulation, which helps to maintain the value of the remaining tokens and prevents the asset from losing value.
Maintaining/Increasing Value
As mentioned earlier, burning tokens can also help maintain or increase the value of a cryptocurrency. By reducing the number of tokens in circulation, the demand for the remaining tokens can increase, increasing their value. Some projects’ communities engage in large scale token burns, which drives publicity, subsequently raising awareness of the cryptocurrency, increasing demand and raising the token price. This can be particularly beneficial for investors who hold a significant amount of cryptocurrency, especially if they are a high profile member of the community.
Cons of Burning Tokens
While burning tokens can potentially drive up the value of cryptocurrency, there are also disadvantages of burning tokens:
Permanent Removal of Assets
One of the major drawbacks of burning tokens is that the coins are permanently removed from circulation. If the cryptocurrency has a fixed supply and starts to experience a significant increase in demand in the future, the reduced circulating supply may limit its ability to meet that demand, leading to missed opportunities for the asset.
Large Quantities Needed to Make an Impact
Another issue with burning tokens is that you need to remove a significant number of tokens from circulation to have a noticeable impact on the asset's market value. This can be difficult to achieve, especially for projects with a limited supply and those without a large supply of tokens, or an active community to drive publicity.
Shiba Inu Coin Burn
Shiba Inu (SHIB) is a cryptocurrency that gained significant attention in 2021. It was created as a meme token and modeled after Dogecoin (DOGE), created as a joke based on a popular internet meme. SHIB's rise in popularity is primarily due to its vibrant online community and the support of several high-profile individuals. Originally, there were one quadrillion SHIB tokens, which were all minted at the same time. Of these, 50% were locked in Uniswap for liquidity purposes, and the remaining 50% sent to Ethereum creator Vitalik Buterin’s public wallet. Buterin burned 90% of the SHIB tokens sent to his wallet, and donated the rest to the India Covid relief efforts.
To date, over 410 trillion SHIB has been burnt.
There are several reasons why the Shiba Inu project implemented coin burning:
Scarcity
One of the primary reasons why the Shiba Inu project has implemented a coin-burning mechanism is to increase the scarcity of the token. The project aims to make the remaining tokens more valuable by reducing the total supply of tokens in circulation. This can create a sense of scarcity, which can attract more investors to the project and drive up the token price.
Price Stability
The second reason why the Shiba Inu project has implemented a coin-burning mechanism is to promote price stability. By reducing the total supply of SHIB tokens in circulation, the project aims to prevent the price from fluctuating too much. This helps create a more stable and predictable market for the token, which can attract more long-term investors.
Value Proposition
The Shiba Inu project aims to create a decentralized ecosystem for the token, and a coin-burning mechanism can help strengthen its token's value proposition. By reducing the total supply of tokens in circulation, the project can make the remaining tokens more valuable and increase the value proposition of the token.
Community Engagement
The Shiba Inu project has a strong community of supporters, and a coin-burning mechanism can help to engage and incentivize the community. By burning tokens, the project can demonstrate its commitment to the community and create a sense of shared ownership and responsibility for the project.
How to Burn SHIB
In July 2021, the Shiba Inu community launched a burn portal called ShibaBurn on ShibaSwap. The portal allowed users to burn SHIB tokens to receive a share of the 0.49% of RYOSHI transactions set aside for community burn efforts in the future. This permanently removes the tokens from circulation, and the process was meant to increase the value of the remaining tokens.
Shibarium Burn Mechanism
The Shiba Inu community announced the launch of a new burn mechanism as part of its upcoming Layer 2, Shibarium. Shibarium is an ecosystem of decentralized applications (dApps) that run on the Ethereum network. It is designed to be a platform for developers to create new applications compatible with Shiba Inu.
While BONE will serve as the gas token within Shibarium, the team has formally announced that every Shibarium transaction will also burn SHIB, effectively eliminating a certain percentage of tokens from circulation permanently with every transaction. The token burning mechanism could boost the value of SHIB and help it grow via deflationary tokenomics.
Shibarium Update 🧵
— Shibarium Network (@ShibariumNet) January 7, 2023
While on our last post we wanted to remind everyone that BONE 🍖 serves as the required gas token for operability within Shibarium, we also would now like to formally announce that each #Shibarium transaction will burn 🔥 SHIB.
1/2 🧵 pic.twitter.com/zQRoOuL9oW
Example of Token Burn: Ethereum
Ethereum is one of the largest and most popular networks in the world. It is a decentralized blockchain platform that allows developers to deploy dApps and smart contracts. ETH is the native currency of Ethereum and is the second-largest cryptocurrency by market capitalization after Bitcoin (BTC). ETH is used to pay for gas fees and incentivize miners to process transactions and secure the network.
Ethereum Fee Burning with the London Upgrade
In August 2021, Ethereum implemented a significant upgrade called the London hard fork. The upgrade introduced several new features, including a fee-burning mechanism. With fee burning, a portion of the transaction fee paid by users is burned, meaning that it is permanently removed from circulation. Below are the reasons why Ethereum implemented a fee-burning mechanism:
Managing inflation: Ethereum has a dynamic block size, meaning the number of new ETH tokens issued for each block is not fixed. This enables it to adjust the block reward and manage the inflation rate of ETH. However, the fee-burning mechanism enables Ethereum to further manage the inflation rate by destroying a portion of the tokens in circulation, reducing the total supply of ETH and potentially increasing its value.
Increasing demand: By reducing the total supply of ETH, the coin burn mechanism can increase the demand for ETH, as fewer tokens will be available to purchase. This could likely increase the value of ETH and make it more attractive to investors.
Aligning incentives: The token burn mechanism can help to align incentives between different stakeholders in the Ethereum ecosystem, such as stakers, developers, and investors. By reducing the total supply of ETH, the mechanism can increase the token's value, benefiting all stakeholders in the ecosystem.
Impact of London Upgrade Post-Merge
With a portion of the gas fees burned and removed from circulation, coupled with an increase in on-chain activity, such as minting XEN, along with Ethereum's switch to Proof-of-Stake, ETH's supply rate has significantly declined and is currently negative.
Conclusion
Burning tokens is a popular mechanism used by cryptocurrencies to manage their supply and increase their value. The process involves permanently removing a portion of a cryptocurrency's tokens from circulation. While coin burn can have several benefits, including curbing inflation and increasing the value of the remaining tokens, it also has its drawbacks, such as the permanent removal of assets and the need for many tokens to make an impact. Additionally, the effect of coin burn can vary depending on several factors, such as the cryptocurrency's technology, the community's decision, and the overall market conditions. It is important to note that coin burn is not a foolproof method of managing the supply and value of a cryptocurrency.
Josiah is a tech evangelist passionate about helping the world understand Blockchain, Crypto, NFT, DeFi, Tokenization, Fintech, and Web3 concepts. His hobbies are listening to music and playing football. Follow the author on Twitter @TechWriting001
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