What Does It Mean To Burn Crypto?

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Last updated Jun 24, 2024 | 11:23 AM UTC

Crypto works on the simple basis of supply and demand. Most cryptocurrencies have a fixed number of tokens in supply. For instance, the maximum number of Bitcoins available is 21 million. So the blockchain won't produce more than 21 million BTC tokens in circulation. 

The value of a token often depends on its circulating supply, which is the total number of coins or tokens available in the market at any given time. Burning cryptocurrency involves permanently removing a portion of these tokens from circulation. This is usually done to reduce the overall supply, potentially increasing the value of the remaining tokens.

Imagine a popular collectible item, like a limited edition toy. If many of these toys are available, their value might be lower because they are not scarce. However, if a significant number of these toys are destroyed, the remaining ones become rarer and more valuable.

Similarly, when crypto tokens are burned, the reduced supply can make the remaining tokens more valuable, assuming demand remains constant or increases.

Let's explore this concept of cryptocurrency burning more in-depth.

What is cryptocurrency burning?

Cryptocurrency burning refers to the process of permanently removing a certain amount of tokens from circulation. This is achieved by sending these tokens to a burn address, which is a wallet that no one can access. The burned tokens are effectively destroyed, reducing the overall supply of the cryptocurrency.

There are several methods to burn crypto. One common method involves sending tokens to an unspendable address, often called a 'black hole'. This address has no known private key, ensuring that the tokens cannot be retrieved or spent. Another method is through smart contracts that automatically burn tokens under specific conditions.

Several well-known cryptocurrencies have utilized burning. For instance, Binance Coin (BNB) undergoes quarterly burns based on the trading volume on the Binance exchange. Similarly, Ethereum has implemented a burning mechanism as part of its Ethereum Improvement Proposal (EIP) 1559, which burns a portion of the transaction fees.

Burning tokens can have significant implications for the market. By reducing the supply, it can create scarcity, potentially leading to an increase in the value of the remaining tokens. However, the actual impact on price depends on various factors, including market demand and overall sentiment.

Reasons for burning cryptocurrency

Burning cryptocurrency is a strategic decision often made by companies and projects to achieve specific goals. Understanding the reasons behind this practice provides insight into its broader implications.

Why do companies burn cryptocurrency?

Companies burn cryptocurrency for several reasons. One primary reason is to control inflation. By reducing the number of tokens in circulation, companies can prevent the devaluation of their currency due to oversupply. This strategy helps maintain the token's value and attractiveness to investors.

Intentional burns to increase value

Oftentimes in the crypto market, intentional burns are conducted to increase the value of the remaining tokens. This decision is generally made through community proposals and voting. The FLOKI token burn is a recent example of this method. The meme coin’s community voted in February 2024 to burn a certain amount of tokens, which ultimately led to a bullish cycle for FLOKI. 

When tokens are burned, the total supply decreases. According to basic economic principles, if demand remains constant or increases while supply decreases, the value of the remaining tokens can rise. This can make the cryptocurrency more appealing to current and potential investors.

Reduction of circulating supply to create scarcity

Creating scarcity is another key reason for burning tokens. Scarcity can drive demand, as investors and users perceive the tokens as more valuable. This is particularly effective in speculative markets, where perceived value can significantly influence buying behavior.

Proof-of-burn as a consensus mechanism

Proof-of-burn is a consensus mechanism used by some blockchains to validate transactions and create new blocks. In this process, miners burn a portion of their tokens to demonstrate their commitment to the network. This burned amount serves as proof of their investment and helps secure the network. Proof-of-burn combines elements of proof-of-work and proof-of-stake, offering an alternative method for maintaining blockchain integrity.

Enhancing trust and transparency

Regular token burns can enhance trust and transparency within the cryptocurrency community. By committing to a predetermined burn schedule, companies show their dedication to long-term value creation and transparent practices. This can build investor confidence and foster a loyal user base.

Marketing and investor relations

Token burns can also be used as a marketing tool. Announcing a token burn can generate buzz and attract media attention, drawing in new investors and users. It signals that the project is actively managing its token economy, which can be reassuring to the community.

Advantages and disadvantages of burning crypto

Advantages

Potential increase in value:

  • Burning tokens reduces the total supply, creating scarcity.
  • With a lower supply and steady or increased demand, token prices can rise.
  • This can make the cryptocurrency more attractive to investors.

Enhanced trust and transparency:

  • Regular burns demonstrate a company’s commitment to long-term value.
  • A transparent burn schedule can build investor confidence.
  • It signals responsible management of the token economy.

Controlled inflation:

  • Burning helps manage the token supply, preventing devaluation.
  • It maintains the currency’s value over time.
  • Reducing circulating tokens can protect against oversupply.

Proof-of-burn consensus mechanism:

  • Combines elements of proof-of-work and proof-of-stake.
  • Provides an alternative method for securing blockchain integrity.
  • Miners demonstrate commitment by burning tokens, enhancing network security.

Marketing and investor relations:

  • Token burns can generate media attention and attract new investors.
  • Announcing burns can create excitement within the community.
  • It demonstrates active management and strategic planning.

Disadvantages

Irreversible nature of burns:

  • Once tokens are burned, they cannot be recovered.
  • This permanence can be a risk if the decision is later regretted.
  • Miscalculations in burn amounts can have long-term impacts.

Potential for manipulation:

  • Companies might burn tokens to artificially inflate prices.
  • This can mislead investors and distort market perceptions.
  • It raises concerns about the ethical use of burning practices.

Short-term focus:

  • Burns might prioritize immediate price increases over long-term stability.
  • Short-term gains can overshadow sustainable growth strategies.
  • Investors might react to burns without considering broader market trends.

Impact on liquidity:

  • Reducing the number of tokens can affect liquidity.
  • It might become harder to buy or sell tokens in large volumes.
  • Limited liquidity can lead to increased price volatility.

Dependence on market conditions:

  • The success of burns in increasing value depends on market demand.
  • In bearish markets, burns might not lead to significant price rises.
  • Market sentiment plays a crucial role in the effectiveness of burns.

How do you burn cryptocurrency tokens?

Burning cryptocurrency tokens involves a specific set of steps and methods. Here's a detailed guide on how to perform this process and its practical applications.

Choose the tokens to burn:

  • Decide which tokens and how many to burn.
  • Ensure the tokens are available in a wallet you control.

Generate a burn address:

  • Create a burn address, also known as a black hole address.
  • This address is a wallet with no known private key, making the tokens sent to it inaccessible.

Send tokens to the burn address:

  • Transfer the chosen amount of tokens from your wallet to the burn address.
  • Ensure the transaction is correctly recorded on the blockchain.

Verify the burn:

  • Check the blockchain explorer to confirm the tokens have been sent to the burn address.
  • Record the transaction details for transparency and future reference.

Practical applications for coin burning

Burning cryptocurrency tokens can reduce supply and potentially increase value. This happens because, according to economic principles, reducing supply while maintaining or increasing demand can drive up the price. Companies often use token burns as part of a token buyback and burn program. They purchase tokens from the market and burn them to support the token’s price and demonstrate a commitment to long-term value creation.

Proof-of-burn serves as a consensus mechanism on some blockchains. In this process, miners burn tokens to prove their commitment to the network, thus securing it. This method combines elements of proof-of-work and proof-of-stake, providing an innovative way to achieve consensus and validate transactions.

How does burning crypto impact its value?

Burning crypto impacts its value through several mechanisms. Firstly, reducing the supply can create scarcity, potentially increasing the value of the remaining tokens if demand stays the same or rises. Market perception also plays a significant role; regular and transparent token burns can signal positive management practices and enhance investor confidence, attracting new participants.

Furthermore, burning helps control inflation by managing the number of tokens in circulation, which can stabilize or increase the token's value over time. This practice can make the cryptocurrency more appealing as a long-term investment, as it shows a commitment to maintaining and increasing token value.

Final thoughts

Burning cryptocurrency is a strategic practice with significant implications for the crypto market. By understanding what it means to burn crypto, the reasons behind it, and its advantages and disadvantages, stakeholders can better navigate this complex landscape.

Whether you're an investor, developer, or enthusiast, grasping the concept of cryptocurrency burning is crucial for understanding key market dynamics. 

Frequently Asked Questions

How does burning crypto work?

Burning crypto involves permanently removing tokens from circulation by sending them to an unspendable address, known as a burn address. This address has no private key, making the tokens irretrievable and effectively destroying them. This reduces the total supply of the cryptocurrency.

Why do people burn crypto?

People burn crypto to reduce the circulating supply, which can increase the value of the remaining tokens due to scarcity. Companies also burn tokens to control inflation, enhance trust and transparency, and sometimes as part of a proof of burn consensus mechanism.

What are examples of cryptocurrencies that can be burned?

Examples of cryptocurrencies that can be burned include Binance Coin (BNB), which undergoes quarterly burns, and Ethereum (ETH), which burns a portion of transaction fees as part of its EIP-1559 protocol. Other cryptocurrencies like Stellar (XLM) and Bitcoin (BTC) have also seen burning events.

Written by

Mohammad is an experienced crypto writer with a specialisation in cybersecurity. He covers a wide variety of topics spanning everything from blockchain and Web3 to the retail crypto space. He has also worked for several start-ups and ICOs, gaining insight into the mindset and motivation of the founders behind the projects.