Burning crypto may sound absurd to most people mainly because burned tokens are typically valuable, which means that value is being destroyed. But there’s logic and reasoning behind token burns. Read on to find out what it means to burn coins and why crypto ventures do it.
What Does Burning Coins Mean?
Burning coins means intentionally sending tokens to an “eater” or “burn” address to pull them from circulation. Once burnt, these tokens are gone because no one can access burn addresses since their private keys are not known to anybody and they’re designed only to receive coins.
So, tokens are gone forever once project developers send them to a burn address. However, the burn transaction is publicly visible on the blockchain to prove that the tokens have been burnt.
Developers typically take tokens for burning from the supply they have set aside and have at their disposal. Alternatively, they may purchase tokens back from the market for a coin-burning event. Some projects may even have token-burning events built into the token protocol.
In traditional markets, companies that issue stocks may purchase shares back at the market price to minimize the overall amount of shares in the market. This process is called a stock buyback. Crypto projects are applying the same concept to achieve a similar goal.
Coin burning gained popularity in 2017 and 2018 when coins like Binance’s BNB token held burning events to lower supply in the hope that it would increase token prices.
Why Would Someone Burn Crypto?
People burn crypto for various reasons. Let’s take a look at some of the most common reasons for token burns.
Boosting Token Value
Crypto projects primarily burn crypto for deflationary reasons. By reducing a token’s circulating supply, they create scarcity and the value of the token may rise as a result. This could attract more investors to the project.
The increase in token value, however, doesn’t necessarily happen overnight, and in some cases, it might not happen at all. Still, crypto burning is generally considered a favorable move for tokenholders.
Earning Rewards on Proof-of Burn Blockchains
Crypto projects that use the proof-of-burn (PoB) consensus mechanism also burn tokens. PoB is similar to Bitcoin’s proof-of-work (PoW) consensus mechanism. However, it consumes less energy.
PoB blockchain networks use coin burning to validate transactions. Miners reach consensus through the burning of coins. Instead of using physical mining rigs like those used by Bitcoin miners, miners in PoB blockchains use virtual ones.
Miners that burn more coins than others have a higher virtual mining power, which allows them to mine new blocks with a high probability and add them to the network. Hence, they earn more block rewards.
Miners initiate coin burns by sending tokens to an eater address. This shows their commitment to the network, allowing them to mine blocks. Miners receive rewards in the blockchain’s native cryptocurrency in exchange for their participation in the network. Coin burning keeps the network secure and helps it to run effeciently.
Maintaining the Fixed Value of Algorithmic Stablecoins
Algorithmic stablecoins are cryptocurrencies powered by algorithms and a coin burn and mint process that are designed to maintain a stable price. An on-chain algorithm (smart contract) controls the change in demand and supply of the two cryptocurrencies.
A stablecoin may be designed to maintain a fixed exchange rate of US$1, for example. When the demand for a stablecoin increases and its price rises above $1, the smart contract issues more tokens to bring the price down to $1. Conversely, when the price of a stablecoin slides below $1, the smart contract burns tokens to bring the price back up to $1.
Increasing the Scarcity of NFT Art
Pak, an anonymous but popular NFT artist, launched burn.art in April 2021. This NFT burning platform allows NFT owners to burn non-fungible tokens (NFTs). This makes the remaining tokens in the collection rarer, which might be suitable for the collectors.
In exchange for burning NFTs, they get Burn tokens (ASH). ASH is a social currency built on Ethereum (ERC-20). Pak’s NFTs generate more ASH than other NFTs. In the future, collectors can only buy Pak’s NFTs with ASH.
How Can You Burn Tokens?
Projects use smart contracts to burn tokens. This is a technical process, but it essentially entails telling the smart contract the number of coins they want to burn. The smart contract will then verify that they have enough coins in their wallets and subsequently executes the burn. The smart contract will send tokens to a randomly generated address that’s inaccessible.
Now let’s take a look at an example of a coin burn, where we burn an NFT (ERC-721 token) on Etherscan.
Here are the steps:
- Click the contract address of your NFT. This address should be available on the platform you minted the NFT. The address will open on Etherscan, a block explorer for Ethereum-based tokens.
- Next, go to the contract tab.
- Click “Write Contract.”
- Scroll down and go to the “Burn” option.
- Enter the address of the wallet holding the NFT in the first field.
- Copy the token ID from the NFT platform and paste it into the second field.
- Indicate the number of tokens you want to burn in the last field.
- Click “Write” to execute the burn transaction.
A coin burn is recorded as a transaction on the blockchain and is visible to everyone. It is also permanent and irreversible. So if you are going to try this, don’t do it with your favorite NFT.
Examples of Coin Burns
Binance regularly auto-burns BNB tokens. The goal is to reduce the total supply to 100 million BNB. So far, Binance has burned 36.8 million tokens. The burn transactions are publicly visible on BscScan, a block explorer for the Binance blockchain. BNB burning started in October 2017.
In 2019, the Stellar Development Foundation (SDF) burned 55 million Stellar Lumens (XLM), more than half of the token’s supply. The project burned the tokens because it was hard to get lumens into the market. At the time, the burned XLM coins were worth about $4.7 billion.
Since the launch of the Ethereum London hard fork, also known as EIP-1559, in August 2021, Ethereum has burned about 2.5 million ETH. This amount was worth around $3 billion, at the time of writing this article. EIP-1559 was a network upgrade that introduced a new gas fee structure
In November 2021, the Terra project burned 88.7 million LUNA tokens to reduce the supply in Terra’s community pool. The burned coins were worth roughly $4.5 billion at the time.
FAQs
Are Coin Burns Good or Bad?
Generally speaking, restricting the supply of a cryptocurrency should lead to an increase in the value of the existing tokens as they become scarcer. As such, coin burns are typically considered positive and welcomed by tokenholders. However, not every coin burn leads to a price increase for the burned token.
What Are the Risks of Coin Burns?
Coin burns could lead to centralized control when the development team uses burn wallets to hide large token holders referred to as whales. Also, projects can use coin burning to implement scams known as rug pulls. They do this by claiming they have burned a particular amount of tokens while, in reality, the “burned” tokens remain in a wallet they can control.
How Can You Protect Yourself from Coin Burn Scams?
Always conduct thorough research before buying any crypto tokens. Look out for red flags like anonymous founders, unclear project objectives, no real token use case, and a non-existent project roadmap.
Also, never reveal your wallet’s private keys if you are asked to as part of a project’s token burn. If someone is asking for your private keys or recovery phrase, they are trying to scam you 100% of the time.
Sourced from crypto.news.
Written by Alex Lielacher on 2022-07-17 04:00:00.
