What Is Token Burning?

You may have heard about a token burn. It is a process where crypto coins or tokens are burned to reduce the total number of coins in circulation. These tokens are not literally burned; they are destroyed, for example, by sending them to an address that does not exist.

There can be several reasons behind a token burn. Subsequently, it is also possible to perform a token burn in different ways. In this article we will explain what a token burn is and why it occurs and also provide you with an example.

Why Are Tokens Burned?

Token burning is when a cryptocurrency project permanently removes (or “burns”) tokens from circulation, reducing the overall supply of the token. It may sound a little extreme, but burning is common in crypto and often beneficial.

Tokens are usually burned for deflationary purposes, as most cryptocurrency projects burn tokens to maintain their value. Another reason could be that this mechanism is aimed at controlling inflation in a token’s economy. Cutting down the supply of a token can increase its value, as there will be fewer coins available to sell. If demand is high, its value will rise even more.

For example, back in 2019, the Stellar network burned 55 billion of its XLM tokens, drastically reducing its supply by over 50%. This resulted in the token’s value jumping from $0.069 to $0.088 in a single day.

How Does it Work?

There are several ways to burn tokens, but the most common approach is when a specific number of tokens are purchased, then transferred to a frozen private address, or a “burn address”. Once they have been transferred, they cannot be retrieved as there is no private key linked to the burn address. In other words, the tokens no longer exist and have now been burned.

The Ripple network utilizes a different way to burn its tokens. It does so by reducing the number of transactions allowed on its network to prevent the possibility of a denial-of-service (DDoS) attack, which itself is a malicious attempt to disrupt the regular traffic of a server or network. Ripple also takes gas fees to speed up a transaction, which in turn reduces the supply of XRP in circulation for every transaction made.

The Different Types of Token Burning

There are different ways and reasons to burn tokens. These are the 3 main types of a token burn:

1. It is predetermined in the white paper. It can happen on a fixed date or when certain conditions are met.
2. The tokens are burned when users perform a certain action. For example, think of buying a product with tokens. The company may have decided that X% of the tokens would be burned after each purchase.
3. The founder team decides that there are too many tokens. By burning tokens, the team can get more attention among crypto traders, and can also enhance the technology.

Each of these different ways of doing a burn will reduce the total number of tokens in circulation. In order for token burning to be effective, it is crucial for it to be transparent and verifiable. The burning of tokens should be transparently announced by token issuers, and holders should have a method to monitor and verify it. This helps to build trust among holders.

Does a Token Burn Cause the Price to Rise?

According to the economic law of supply and demand, a token burn should logically lead to an increase in the price of the cryptocurrency. But is this really the case in practice?

After all, the market of cryptocurrencies is not the same as that of any other product. Generally speaking, the crypto market is incredibly volatile. As a result, the market can also react very differently to burning tokens.

How Is Token Burning Beneficial?

Aside from increasing a token’s value, burning can also be beneficial in incentivising investors to hold them.

When a network conducts a token burn, the decrease in supply results in an increase of value. Therefore, anyone who holds the token will immediately see an increase in the value of their holdings.

That is why token burning builds a good level of trust and confidence in the community, with many crypto projects using it as part of their marketing tactics to attract investors.

So, despite the intense-sounding name, token burning actually does a lot of good for both tokens and their holders, since it can increase a crypto’s value.

A token burn can also happen accidentally, when a user sends his tokens to the wrong address for example, but it can also be carried out intentionally. The team behind a crypto project may have different reasons for burning tokens:

1. This is agreed upon in the project’s white paper.
2. Users perform a certain action that causes token burn to occur automatically.
3. They want to drive up the price of the token by reducing the supply.
4. In the past, there have been several token burns that had a positive effect on the cryptocurrency. Of course, this is no guarantee for the future. Therefore, always do proper research on a cryptocurrency when a token burn occurs.

Cons of Token Burning

There are several potential downsides to token burning:

• Reduced liquidity: If a large number of tokens are burned, it can make it harder for holders to buy or sell the remaining tokens, as there are fewer of them available on the market.

• Centralization: If only a small group of token holders are able to participate in the token burning, it can lead to centralization and concentration of wealth among a small group of individuals.

• Lack of transparency: Token burning can be difficult to verify, and if the process is not transparent, it can lead to mistrust among holders.

The choice to carry out a token burn should be well thought out and evaluated in light of the unique conditions around the token and its economy.

Conclusion

Token Burn has several beneficial factors, depending upon the different scenarios you want to use it for. Aside from increasing a token’s value, burning can also be beneficial in incentivising investors to hold them.

Also, there are quite a few cryptocurrencies that have implemented the Token Burn directly to avoid ICOs or token sales, and there are many out there that frequently and purposely burn coins to reward their token holders.