What is Token Burning and Why Does It Matter?

What is Token Burning?

Blockchains issue cryptocurrencies that are used as a medium of exchange. Much like fiat currencies, virtual currencies also run the risk of devaluation if their supply continues to increase. This problem is addressed by blockchains by incorporating various methods to control the total supply and circulatory supply of a cryptocurrency.

In this manner, the blockchain ensures that the value of a given virtual currency is retained. Coin burning is one of the methods to limit the supply of a cryptocurrency.

How does Coin Burning Work?

Various blockchains have adopted different methods for coin burning. The most common burning method is sending a portion of cryptocurrencies to burn addresses. These addresses are wallets that are unusable and when coins are sent to such an address it means it is taken out of the circulatory supply.

However, there are also instances where independent token projects adopt independent token burning mechanisms. The Shiba Inu project has a burn portal that rewards investors for sending SHIB tokens the portal.

Binance Chain has smart contracts that enable users to send coins from their wallet reserves to burn addresses.

Applications of Token Burning

Here are some applications of token burning mentioned as under:

Proof of Burn

Proof of Burn (PoB) is a type of consensus mechanism that is used to verify transactions. Miners are able to burn tokens without any energy waste. PoB is verified on a blockchain explorer.

This method is used to prevent frauds by automation of verification for each transaction on the network. At the same time, miners are able to mine new coins after burning coins and mine new blocks.  

Price Momentum

One of the main reasons to burn coins is to retain the value of a cryptocurrency. If the total number of a given coin continues to increase overtime, the value of that coin will automatically dwindle.

Therefore, blockchains and cryptocurrency investors use burning method to maintain a positive price momentum for digital currencies.

Coin burning projects are often community driven events that are coordinated through blockchain forums and social media. Investors may also burn a large portion of their reserves and post details about it on social media to raise awareness and increase demand.

Mining Balance

Mining speed declines with minting of a new token. However, token burning allows miners the ability to mine more tokens. PoB is customizable therefore in some cases; miners do not have to burn the same tokens they are mining in exchange for various rewards and maintain a healthy network ecosystem.

Advantages of Coin Burning

Here are some important advantages of Coin burning:

Retain Value

The main aim of burning tokens is to stabilize the price and maintain goodwill among investors. In this manner, the demand for a given virtual currency is retained for longer durations and remains stable.

At the same time, reducing the total quantity of a given cryptocurrency also ensures higher prices that benefit the investors.  Blockchain projects or communities schedule regular token burning events to increase demand, increment price, and reduce overall supply.

Community Interactions

Cryptocurrencies that have managed to retain their value for a longer duration and are ranked among the top projects often have dedicated communities.

These communities take an organized approach and establish active communication channels for coordination. When coin burning events are coordinated by the community, they are more effective and have a faster impact.

Risks Associated with Token Burning

Here are some risks associated with token burning:

Permanent Losses

When a cryptocurrency investor burns tokens, it means that the burned coins are taken out of their wallet for good. Burning tokens is a process that leads to permanent loss.

The investors do not have any warranty that burning tokens is going to increase the value of the remaining coins in their accounts. Therefore, they take a calculated risk of sending a portion of their coin reserves.

Large Quantity Requirements

Token burning is a method to control the overall supply of a given cryptocurrency.  However, the process is only successful if a large quantity of coins is burned.

Conclusion

Coin burning is a process to make a cryptocurrency project deflationary. Blockchains have incorporated other types of supply control methods such as Bitcoin halving and EIP-1159 fee burning for Ethereum blockchain, etc.