What Does It Mean To Burn Crypto?
KEY TAKEAWAYS:
- Crypto burning basically means sending your coins intentionally into a digital wallet
that you don’t have access to in order to keep it lost forever. - Crypto burning is a form of mechanism used to control the circulation of coin in the
cryptocurrency ecosystem. - Crypto burning can either be done unilaterally by a developer or communally in a
DAO. - Only burner or eater addresses are used for crypto burning.
What Does It Mean To Burn Crypto?
Burning cryptocurrency does not mean that you set fires to a cryptocurrency, like you can burn paper money. To burn crypto means sending it to a digital wallet that can only receive but not send out crypto.
If you want to understand this better, imagine that you have a bank account created only to receive money. It means that you cannot withdraw money from such an account, and any money sent into it is lost forever.
This is what it means when users or a community say they have decided to burn a particular cryptocurrency, or that they burned their coin. The wallet address used in this action is a burner address, or an eater address.
The primary reason why protocols burn their coins is to reduce the overall supply of the coin and, in the same light, increase its value. The major market influencers are demand and supply. When there is less coin supply in the crypto ecosystem, there is often less demand, reducing the value of such coins.
When cryptos are burned in a deflationary event, it leads to a scarcity of the coin, and the demand increases the value and price of the coin. This price increase only happens after a while. Some experts have found a way to predict when a burn will happen, so prepare for it since most burns occur using smart contracts.
There are many ways coin burning happens. Most protocols have a smart contract that moderates their coin’s demand and supply.
The smart contract determines when the burn is needed, and when demand increases, it knows when to mint new coins for the market.
Some protocols do not use smart contracts since they exist in a decentralized autonomous organization.
In DAOs, burning happens when the community votes for it to occur. At this point, every community member burns a certain amount of their coin. The last method is passive and usually not noticeable. For example, Ethereum burns a small percentage of Ether during every transaction. This happens over a long period, and users must take note of it.
Also read: What is an IDO?
Why Do we Burn Crypto?
As decentralized finance (DeFi) protocols continue to gain popularity, more projects are burning their coins. Here are a few reasons why burning coins is a logical choice for a community or as a protocol.
Long-Term Commitment
To gain investments and funds, project owners sometimes burn coins on their network to show that they are committed to limiting the coins’ supply. The owners of a protocol or project can do this by burning coins at certain times or just once.
Some investors see this as a way to help a coin’s value grow and may feel more confident about keeping their investment for a long time.
Value of Coin
When coins are burned, this leaves a smaller amount in the market. This mechanism drives up the coin’s value since fewer coins are available on the market. The fundamental laws of economics dictate that when the supply of a commodity decreases, then the demand for and value of such a commodity will increase, so long as there is still demand for the commodity.
Engaging in coin burning can sometimes be an effort to manage supply in a way that increases scarcity and tries to mimic Bitcoin’s supply and demand dynamics.
An Incentive for Miners
Sometimes, the PoB (Proof of Burn) system can burn crypto coins regularly to keep a balance between new users and early investors, who might have more coins. The PoB consensus mechanism uses burned coins to validate transactions, encouraging the creation of new coins.
This helps to balance things out between new and old users.
Spam Protection
When you make a transaction using Bitcoin, you usually pay a transaction fee for the process to work. Sometimes this is known as a gas fee, like for smart contract creation.
To protect the system from Spam and Distributed Denial-of-Service (DDoS) attacks, miners usually ask that users burn the gas fees they receive. This method helps keep Spam away and increases the coin’s value.
Consensus Mechanism
A consensus mechanism for crypto burning is that miners and users agree to burn coins simultaneously, or regularly. This burning is done because some coins use proof-of-burning, also known as PoB, to verify transactions.
When miners burn coins during a transaction, they are rewarded with new coins when the transaction is confirmed.
Stabilizing Stablecoins
Sometimes stablecoins may need to burn a portion of their supply to stay pegged to a fiat currency (like the dollar). This means they get rid of some of their coins to help maintain the value of the stablecoin.
If the demand for a stablecoin increases and the price goes above its dollar value, the smart contract that controls the stablecoin will create new tokens to lower the price or burn coins to increase the price and keep the dollar value the same.
Also read: What is sharding?
Benefits of Burning Crypto
Burning crypto has two major benefits – increasing or maintaining the coin’s value and strengthening the crypto ecosystem. As a user, it is very unlikely that you will set up a burner wallet address to send coins to that you can never retrieve.
This mechanism sounds wrong and illogical to anyone, but the benefits, in most cases, outweigh the loss.
Maintaining the Price of Coins for Investors
The purpose of token burning is to stabilize prices and help investors feel more confident. If the demand for a coin stays the same, but the overall supply decreases, the coin’s price can go up. Bitcoin, for instance, does this by halving the coin in circulation every four years.
Experts have said that a halving event is a form of driving value for the coin and a way to keep investors tied to the coin.
Strengthening the Crypto Ecosystem
Some of the most popular coins in the crypto market have a strong community base supporting them. Protocols that have made their mark usually have many people working on them and many investors using them.
With concepts such as DAO, a group of people from anywhere in the world can work together to ensure a successful protocol. In the same light, burning coins is also a way to do that. Crypto burning encourages others to invest in or get involved with the project.
Demerits of Burning Crypto
There are a lot of reasons why burning crypto is terrible. The impact, for instance, is high on the quantity of the coin in the market. As such, you should know what you are getting into before doing it. Protocols will often have their burning frequency available for users to see.
Before you purchase a coin, you should consider how often burning will take place and how it is done. Nonetheless, there are two significant harms of burning crypto: the loss of coins and the number of coins burned.
Loss of Coin Assets
Before burning crypto, consider all the factors affecting the coin’s price and how much you want to burn. You need to figure out the current and expected value of the cryptocurrency and remember that once you burn them, those coins are gone from your wallet forever.
As a user, if you burn a large amount of coins, you might regret it later, especially if the token value increases.
Quantity of Coins Burned
Burning a small number of tokens might not significantly impact the price. For example, there are currently 487 trillion Shiba Inu (SHIB) coins in circulation, so burning a few thousand SHIB will not significantly affect the overall supply.
However, since October 2021, the community has burned over 263 billion SHIB, representing around 0.05% of the total circulating supply.
Is Burning Crypto a Good or bad Thing to Do?
In the real world, companies sometimes buy back their stock from their investors and shareholders. They do this to increase their market share value and gain more traction for their company. This method of increasing value is how crypto burning works.
Depending on the investors and their sentimental value, it can have positive or negative effects on the cryptocurrency. Considering the potential outcome before carrying out a deflationary event is essential.
While many projects are using crypto burning to attract people to buy their coins, there are still risks to be considered when it comes to crypto burning.
As a user, developer, or investor, understanding demand is crucial to gauging the value of a cryptocurrency. While burning coins does affect their supply, there must be enough buyers interested in the coin to increase its price.
As a developer, you should also have a clear goal for implementing your burning procedures. If you cannot explain why you have decided to burn your coins, introducing this feature into your protocol is probably not a good idea.
Another possibility that comes with crypto burning is what is known as a rug pull. A Rug pull is when developers of a project siphon money off its investors and users. Some scams have involved users investing in a coin and then losing it through a burning process.
In cases where the developers have a genuine interest in the token, there is no guarantee that burning tokens will increase demand. It’s also worth noting that even successful crypto projects may still need a coin-burning mechanism.
This means that increasing the value of a token is only sometimes dependent on crypto burning.
Some Examples of Crypto Burning
Binance
Binance is one of the largest cryptocurrency exchanges in the crypto ecosystem. You can buy, sell, and digitally trade Bitcoin or Ethereum. It was started in 2017 by a person named Changpeng Zhao.
It is famous for being easy to use and available in many languages. Binance has more things to do than just trade; like futures trading and staking.
Binance has its own coin called Binance Coin (BNB), which users can use to pay for things like trading fees on the website.
Since its release in 2017, Binance has been burning its coin quarterly. This means that after every 3 months, Binance burns some of its coins in circulation.
The platform initially used the trade volume on its website to determine the number of coins to burn. Still, now they use the number of blocks produced on its BNB Smart Chain (BSC) to decide what to burn.
In 2021, Binance introduced a BEP-95. The BEP-95 is a coin-burning process that removes a portion of BNB minted from the BSC.
Binance hopes to stop its quarterly burn once the number of BNB in circulation reaches 100 Million, but it will continue its BEP-95 strategy.
Shiba Inu:
The Shiba Inu Coin (SHIB) is a cryptocurrency created in 2020 by a man named “Ryoshi,” named after the Shiba Inu dog breed. The coin gained much attention in 2021 because of its price, and many people compared it to Dogecoin.
The developer of Shiba Inu Coin wanted to provide a decentralized and community-driven alternative to traditional financial systems, like every other coin.
However, their burning strategy needed to be fixed. As of August 3, 2022, Shiba Inu (SHIB) had a value of $0.000019, and there are approximately 549 trillion SHIB in circulation.
A recent coin burn at the end of July 2022 only resulted in the burning of $13,500 worth of SHIB, representing a mere 0.0002% of the coin’s total supply. Even though SHIB has a strong community, some members are still determining the benefits of SHIB coin burning.
EIP-1559:
Ethereum’s EIP-1559 upgrade of 2021 is a famous example of crypto burning. The upgrade introduced new burning mechanics to the Ethereum blockchain. A portion of every gas fee on Ethereum now automatically goes to a burn address.
The main aim of the upgrade was to make transactions on Ethereum more user-friendly.
Under the new model, the base fee is the minimum amount of gas required to submit a transaction on the Ethereum blockchain. The miner tip incentivizes validators to confirm transactions more quickly.
The base fee is permanently deleted from circulation after a transaction has cleared. At the same time, miners only receive the miner’s tip as their incentive.
EIP-1559 adjusts the block size per transaction volume, automatically adjusting the base fee. This system was designed to avoid Ethereum’s previous first-price auction model, which always favored users willing to pay high fees to confirm their transactions.
Experts have said that the new model introduced by EIP-1559 may have significant implications for Ether’s future supply.
If network activity increases on Ethereum, ETH’s burn rate can exceed its daily issuance. This may make ETH a deflationary asset in the future.
Burning NFTs
We tend to focus on burning coins alone when we think about crypto burning. Still, it is also possible to burn non-fungible tokens (NFTs). NFTs are unique digital assets that cannot be replicated or exchanged one-to-one like regular cryptocurrencies.
Recently, some NFT projects have started incorporating token burn or NFT burning mechanics into their brands.
One example of such a project is Burn.art. The project uses a cryptocurrency called ASH, derived from burning NFTs, as an entry point to its marketplace.
The well-known NFT artist Pak created the project, which allows users to burn their NFTs in exchange for ASH, potentially boosting the value of NFTs from the same collection that is still in supply and granting users access to the platform.
Another example of a project using the crypto burn mechanics is WAGDIE, a collection of pixelated avatars. WAGDIE bought a Mutant Ape NFT worth thousands of dollars and burned it as a tribute to their project.
While this might seem like an unusual marketing tactic, it points out the importance of ownership and personal control regarding digital assets. Being able to do what you want with your digital assets is vital to why they were built.
Even when that means renouncing your ownership of them in a way that ensures they can never be seen again, users are happy to do it.
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