Cryptocurrencies work properly based on strict rules enforced by smart contracts. However, each blockchain has a unique set of rules which explains why some networks burn tokens while others do not. Also, the process of burning cryptocurrency may differ from one blockchain to another. In this article, we explore what burning cryptocurrency means and the reasons for “destroying” the tokens and coins in that way.
What Is Cryptocurrency Burning?
Cryptocurrency burning is a process of permanently removing tokens or coins from the circulating supply. This is different from losing cryptocurrency by sending them by mistake to an incorrect wallet address where you can never recover them.
In most cases, the development teams are responsible for burning crypto, aimed at achieving a certain goal such as securing the network. For example, the team can buy back the tokens and burn them. Alternatively, they can burn the cryptocurrency that they have been holding for that purpose.
How Does Cryptocurrency Burning Work?
There are different methods blockchains can use to burn cryptocurrency, depending on their architecture. The commonest way is to send the tokens to a special wallet address that has no private key. As such there will never be a way to access them, meaning that they are “destroyed” forever.
What this also means is that a user who intends to burn his/her tokens can send them to an invalid wallet address. Technically, this shows that people can burn cryptocurrencies such as Bitcoin, which have no burnt mechanism, by sending them to invalid wallet addresses.
There are also blockchains such as Binance which have burn mechanisms for destroying their native tokens. Therefore, it is possible for any Binance Coin holder to burn it. The coin holder can state the amount he/she wants to burn and make the necessary command. As such the blockchain simply removes the stated amount from the holder’s balance, resulting in the reduction of the circulating supply.
In other situations, the burning process is automatic upon the fulfillment of certain conditions. As an example, certain blockchains, such as Ethereum, burn a certain proportion of the transaction fee. At one time, Shiba Inu established a burn portal where all willing token holders could burn their SHIB.
Reasons for Burning Cryptocurrencies
As previously stated, different blockchains have various reasons for burning cryptos that include increasing the value of the cryptocurrency, promoting the mining balance, and stabilizing the value of stablecoins.
Proof-of-burn (PoB)
Proof-of-burn is another blockchain consensus mechanism, although it is not as popular as the proof-of-work or proof-of-stake ones. The users of certain blockchains, who are committed to the network, can burn their tokens to gain the right to validate transactions or mine the native cryptocurrency.
In this case, the process of burning cryptocurrencies represents virtual mining power. A user who burns more tokens than others has a higher chance to be selected as a transaction validator. The reward which the validators get covers the investment of the tokens they burn. At the same time, burning the cryptocurrency secures the network from attacks.
Protection against Spam
Burning cryptocurrencies means much more than being a consensus mechanism. It protects the network from Distributed Denial of Service (DDoS) attacks where spam requests slow down the network. Therefore, this process decreases the possibility of spam flooding the network.
Intentional Burns to Increase Value
The other major reason why some blockchains burn their native cryptocurrencies is to increase their values. This is because burning cryptocurrency reduces its circulating supply.
According to the law of demand and supply, a decrease in the supply of a token, accompanied by a constant or rising demand is likely to increase its value. This is similar to the practice of buying back stocks to reduce the number of shares in circulation. For the price of the cryptocurrency to rise the blockchain should burn a large quantity of the tokens.
It’s worth noting that it may take a long time before the price rises. Sadly and in the worst cases, the price may not even rise since other factors may come into play.
Stabilizing the Value of Stablecoins
Stablecoins are playing a great role in the crypto ecosystem since people use them as a medium of exchange. The reason why many businesses and individuals accept stablecoins in exchange for goods and services is that the crypto prices are constant over a long period. Investors can check the prices of the more than 1400+ cryptocurrencies, including stablecoins, on the Gate.io cryptocurrency exchange.
Since the peg of algorithmic stablecoins depends on maintaining a balance between supply and demand, burning plays a critical role. Algorithmic stablecoins automatically adjust their supplies to match the market demand.
For example, if the price of the stablecoin decreases, the blockchain burns some of the tokens to maintain the existing price parity. On the contrary, if its price rises the blockchain mints more tokens to match the demand, thereby maintaining the dollar-pegged value.
As a Sign of Long-Term Commitment
Some development teams incorporate periodic crypto burn mechanisms as part of their smart contracts to maintain the scarcity of the cryptocurrencies. By doing so, they create periodic burn schedules which may help to create upward price momentum for their cryptocurrencies or at least maintain a certain value range.
This strategy helps to keep the confidence of their users as well as attract new investors. Also, these coin burns show the long-term commitment of the team to the future of their projects.
Promoting the Mining Balance
Constant burning crypto helps the blockchain to maintain an investment balance between old users and new ones. This occurs when the blockchain allows the minting of new coins following crypto burn events. With blockchains that use the PoB consensus mechanisms, the users have the chance to mine new tokens or coins after every burn event.
The History of Cryptocurrency Burning
Cryptocurrency burning began in 2017 and expanded in 2018 as more blockchains adopted burn mechanisms. The development teams behind Binance Coin (BNB), Bitcoin Cash (BCH), and Stellar (XLM) were the first to use burn mechanisms to increase the values of their cryptocurrencies.
As an example, Binance carried out many burn events to reduce BNB’s circulating supply by 100 million. Also, by 2019 the Stellar blockchain had burned 55 billion XLM, about half of its total supply. Another notable example is that of Shiba Inu, the memecoin. In 2021, it donated half of its supply to Ethereum co-founder, Vitalik Buterin. However, Buterin burned 90% of the donated SHIB tokens and donated the remainder.
From that period onwards and from time to time, many blockchains have been burning fractions of their crypto holdings to influence their value on the market. For example; recently the Ethereum blockchain introduced the burning of a proportion of its transaction fees as a means to reduce the circulating supply of ETH.
The Reason Why Bitcoin Does Not Need Burning
Bitcoin is one of the blockchains which does not have a coin-burning mechanism. However, there are many BTC that have been burnt by mistake over the years. A project called CounterParty burned 2,124 Bitcoin as part of proof-of-burn to produce its own token called XCP. By the way, CounterParty is an open-source project built on the Bitcoin blockchain.
The probable reason it is not necessary for the Bitcoin blockchain to burn BTC is its relatively small total supply of 21 million. Secondly, it reduces the amount of BTC people mine through its halving events which occur after 210 000 blocks are added to the blockchain.
Can You Burn Bitcoin?
Although Bitcoin does not have a burn mechanism, anyone can burn it by sending it to an invalid wallet address. For example, CounterParty sent its BTC to the wallet address, 1CounterpartyXXXXXXXXXXXXXXXUWLpVr, which acted as its burn address.
Conclusion
Cryptocurrency burning is the process of removing some tokens or coins permanently from circulation by sending them to a wallet that has no private key. Blockchains can burn their tokens for different reasons which include increasing the value of their cryptocurrencies, promoting the mining balance, and stabilizing the value of stablecoins.
