Token Burning Explained

Maintaining the value of an asset can feel like navigating treacherous waters, especially in the world of cryptocurrency. The abundance of coins in circulation and the lightning-fast coin creation leave many investors anxious. Yet, fear not! A band of ingenious cryptocurrencies has risen to the challenge, finding creative ways to keep their coin’s value intact while attracting risk-taking investors.

To that end, Token Burning is a popular method for increasing the value of a coin or token. This procedure includes permanently removing tokens from circulation, hence lowering the cryptocurrency’s overall supply. As a result, scarcity rises, raising the value of each remaining token. This method is particularly crucial for tokens that are vulnerable to swift mining.

What is Token Burning?

Token burning involves reducing the total supply of a cryptocurrency by removing tokens from circulation. This is usually done by transferring the tokens to a wallet with unknown private keys, rendering them inaccessible since the wallet can only receive assets.

While burning a small portion of tokens can help maintain the value of a cryptocurrency, the process of token burning is often a collective effort within the community. At times, significant cryptocurrency holders or individuals with a substantial social media following may encourage the community to participate in the burning process. When everyone burns a small fraction of their holdings simultaneously, it significantly impacts the overall number of coins in circulation, thus influencing the coin’s value.

In some cases, token burning occurs gradually and goes unnoticed by many users. For instance, Ethereum steadily burns a small percentage of Ether with each transaction. Over time, this accumulation results in a decrease in supply, leading to a continuous increase in the coin’s value.

Working Mechanism of Token Burning

Burning tokens can be accomplished in various ways, with the most common method involving sending the tokens to a wallet for destruction. The process is relatively simple; users need only send their coins to a wallet with an invalid address. However, many cryptocurrencies have specific protocols in place for carrying out token burns.

How Token Burning Works

Certain cryptocurrency projects create their own systems for burning tokens. For instance, Shiba Inu introduced an easy-to-use burn portal in April 2022, collaborating with Ryoshis Vision developers. Utilizing this portal allows users to destroy SHIB tokens and receive rewards.

Other cryptocurrencies employ a burn function to eliminate assets. Binance Coin, for example, has a burn function that enables any holder to destroy a specified number of coins from their wallet. Smart contracts verify the availability of the coins in the wallet before subtraction. The total circulating supply of Binance Coin is then automatically adjusted. 

It’s important to note that once coins are burned, they are permanently removed from your account, and there is no way to retrieve them. Before initiating a burn function or sending tokens to an inactive address, double-check all the specified details to ensure accuracy.

In certain instances, the token-burning process occurs automatically. For instance, some networks burn a small fraction of cryptocurrency during mining or as a transaction fee. 

Application of Token Burning

Cryptocurrency holders engage in burning coins and tokens for various reasons, and with advancing technology, they are discovering more innovative applications for this practice. Here are a few examples demonstrating how token burning can be utilized:

Proof of Burn: PoB serves as a consensus mechanism to validate and verify transactions. By employing this algorithm, miners can effectively burn coins without any energy waste. If necessary, PoB can be verified using a blockchain explorer. 

Proof of Work Token Burning

PoB finds several practical applications. Its primary use lies in preventing fraud by automatically verifying each transaction. Additionally, it enables miners to continue mining new coins, as some cryptocurrencies require them to burn coins initially to mine new blocks.

Increase Value: Token burning yields significant benefits for a cryptocurrency’s value. There are multiple reasons why the average price per coin may rise following a substantial burn. The objective of token burning is to reduce the overall supply of a cryptocurrency, thereby increasing its demand. 

However, the exact duration and extent of the price increase per token after each burn remain subject to debate.

Promoting Mining Balance: Maintaining network efficiency can be challenging. With the creation of each new token, mining speed diminishes, giving early miners an unfair advantage over new users. Token burning helps restore balance by granting miners the right to mine new tokens in a more proportionate manner. Instead of burning one token when mining initiates, the process is spread out.

Moreover, miners might not necessarily need to burn the same token they are mining. Customizable proof of burn mechanisms allows networks to offer diverse rewards to miners, fostering healthy network activity. 

Advantages of Token Burning

Assets are never destroyed without a purpose by people. Although it may appear counterproductive to destroy coins and tokens, there are multiple reasons why crypto users engage in burning their digital assets. Apart from gaining mining rights for new blocks, token burning serves the purpose of maintaining the value of an asset. 

Preserving the Value of Coins for Investors:  This practice aims to stabilize prices and instill confidence among investors. When demand remains consistent, reducing the overall supply of a coin can lead to higher prices. Regularly burning cryptocurrency, either with each transaction or on a scheduled basis, enables many altcoins to steadily increase demand over time.

Strengthen Cryptocurrency Communities: Behind some of the most popular altcoins lie thriving communities with numerous enthusiasts and active investors. Implementing large community-driven token-burning initiatives can serve as inspiration for others to invest in or get involved with a particular project.

Disadvantages of Token Burning

Consider these factors before initiating the burning of your tokens. If your intention isn’t to acquire mining rights through token burning, it’s crucial to assess its impact on your portfolio. If token burning occurs automatically, take into account the frequency of your cryptocurrency transactions. The approach a cryptocurrency adopts for token burning can also influence your investment choices. 

Permanent Loss of Assets: Burning tokens requires owning them initially. Once the token burn process is concluded, those tokens are permanently eliminated from your wallet. As a result, even if the token price skyrockets later on, you won’t possess those assets anymore. This could lead to future regret, particularly when burning substantial quantities of coins valued at fractions of a penny. 

Evaluate both the current and anticipated value of the cryptocurrency before proceeding with token burning. Analyze all the factors affecting the coin’s price and carefully determine the amount you wish to burn, keeping in mind that this transaction cannot be undone. 

Large Amounts Needed to Make an Impact: Token burning’s major downside is that small amounts contribute little to price impact. For instance, considering the vast circulating supply of 487 trillion Shiba Inu (SHIB) coins, burning a few thousand SHIB would have an insignificant effect on the overall supply.

Conclusion

Though coin burning does not guarantee an increase in a cryptocurrency’s prices, it can serve as a valuable instrument to preserve value and motivate investors. When deciding to invest in a cryptocurrency, analyze its burn strategy to ensure it aligns with your objectives. Whether you opt for manual coin burning or a cryptocurrency that automatically burns portions of its supply, always maintain a clear understanding of your investment. 

To know more about Token Burning, go check out SunCrypto Academy.

Disclaimer: Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. All content provided is for informational purposes only, and shall not be relied upon as financial/investment advice. Opinions shared, if any, are only shared for information and education purposes. Although the best efforts have been made to ensure all information is accurate and up to date, occasionally unintended errors or misprints may occur. We recommend you to please do your own research or consult an expert before making any investment decision. You may write to us at [email protected].

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