What is the point of burning tokens?

With many cryptocurrencies, the number of circulating tokens increases over time. Consider, for example, Bitcoin (BTC), where the last cryptocurrency is expected to enter circulation in 2140. Other projects, on the other hand, are busy lowering the number of circulating tokens. They do this by means of a symbolic burning.

Token burns take place on the blockchain and ensure that tokens are released from circulation. Any blockchain could perform such token burning, powered by the developers of a project or the community/DAO behind it.

Burning tokens can be for various reasons and be useful. Still, at first glance it may sound crazy for projects to burn their own tokens. So let’s take a look at why a token burn is so important and useful.

Take a quick look

What is a symbolic burn?

In the event of a token burn, tokens are removed from circulation. Each cryptocurrency has a certain number of cryptocurrencies in circulation, part of tokenomics. Increasing the number of circulating tokens is quite easy because you can create new tokens for it. However, withdrawing tokens from circulation is much more difficult. It’s not a matter of tweaking a number. No, they have to burn tokens for it.

A token burn occurs by sending tokens to a non-existent or incorrect address. This is an address that does not belong to anyone. Therefore, no one can access the tokens associated with this address. This ensures that the tokens that are burned can never re-enter circulation.

Of course, this does not mean that the number of circulating tokens cannot grow after a token burn. The developers or community can easily create new tokens for this.

The video below explains what a token burn is and how it works technically.

How does a token burn work?

We will go deeper into why people would burn tokens, but first take a look at how this phenomenon works. With a token burn, tokens are destroyed by sending them to an incorrect or non-existent wallet address.

Each cryptocurrency is linked to a wallet address. This can be a wallet address of a user, but also an address of (for example) a smart contract. In a large database, each token is associated with a wallet address. When the wallet address wants access to its tokens, the computers in the blockchain can immediately see which tokens are linked to the wallet address.

With a token burn, tokens are tied to a wallet address that is incorrect or does not exist. Because you cannot own this wallet address, no one can ever access the tokens associated with this address. It is therefore impossible that someone will later receive a wallet address that is the same as the address to which broken tokens are attached.

It also means that tokens don’t actually ‘disappear’. They still exist, more can never be shipped.

Burn your own tokens

You can also easily burn tokens yourself by sending them to a non-existent address. By the way, don’t try this because it’s impossible to get tokens back. After all, Blockchain has no customer service that can help you with this. Therefore, it is also important to always check the wallet address carefully when sending tokens to other users.

Finding broken tokens in Tokenomics

You can find the burned tokens in the tokenomics of a cryptocurrency. There is always a maximum stock, total stock and circulating stock. You will understand how to find the burned tokens when we look at the difference between these expressions.

  • Maximum stock is the maximum number of tokens that will be created. For Bitcoin, the maximum supply is 21 million BTC and this number will NEVER increase.
  • Total inventory is the maximum supply minus the number of tokens burned. These tokens are no longer released and therefore are not seen as part of the circulating supply.
  • Circulating stock is the number of tokens currently tradable. This number can always increase as the project may release new tokens in the future.

Why should you burn tokens?

Burning tokens may sound strange: why would you do that? Still, there are several reasons why a token burn can be effective and help a project move forward. In fact, many projects wouldn’t do well if they didn’t destroy tokens. Let’s take a look at the main reasons for token burning.

Increase the value

We probably don’t need to tell you that a product becomes more valuable when supply falls against demand. This determines the value of cryptocurrencies. When demand increases and supply decreases or remains the same, the price is likely to increase. This is also the case when the drop in supply is greater than the drop in demand.

Taking tokens out of circulation reduces the supply. This may cause the price of the token to increase, although of course it is never a guarantee. There are also known cases of cryptocurrencies falling after the team decided to burn a large portion of tokens.

A development team must have a good reason for a token burn, otherwise it can cause people to lose faith in the project.

Proof of Combustion (PoB)

Proof-of-Burn is a consensus mechanism, like Proof-of-Work and Proof-of-Stake. This mechanism is used to reach consensus within the network so that nodes can process transactions and create blocks. The difference, however, is that these nodes do this by burning tokens using the token burn principle.

Proof-of-Work requires a node to provide computing power to process transactions, while Proof-of-Stake requires a node to capture tokens. With Proof-of-Burn, a node must send tokens to a non-existent wallet address to show its effort to the network. The node is then allowed to validate transactions to earn money within the blockchain’s network.

Keeping the mining balance the same

When a new cryptocurrency is released from mining, the mining speed is reduced. The miners who have been active for a long time may get an unfair advantage over new miners. In that case, new miners hardly stand a chance. Therefore, developers can choose to burn tokens so that the number of circulating tokens decreases or remains the same. This gives new miners a chance to make money on the network.

This also contributes to the decentralization of the network. When it is attractive to new miners to create a node, they will continue to do so. Otherwise, the network will continue to consist of the same nodes and all blocks will be created by the same nodes.

The token burns in practice

Reasons enough to burn tokens! Still, you don’t hear much about it in practice. However, there are several projects that are about burning tokens. Below you can see a number of examples of token burns in practice.

Binance Coin (BNB)

The most famous example is probably Binance Coin, which runs on the Binance Smart Chain (BSC). An auto-burn is programmed in the protocol. With this, the crypto exchange Binance, the producer of blockchain and cryptocurrency, wants to reduce the number of circulating tokens. This should benefit the price. Why is Binance doing this? Because they want to reward their community for using and holding Binance Coin.

Binance buys BNB tokens every quarter with a portion of the profits. Then these tokens are automatically burned by sending them to non-existent addresses.

Ethereum (ETH)

During the upgrade to Ethereum 2.0, a token burn occurred in the Ethereum blockchain. To be precise, this happened in 2021 during the introduction of the EIP-1559 upgrade. This upgrade was intended to help reduce transaction costs.

At least 2 million ETH tokens were lost during this token burn. After this, several tokens were burned. This shows that a token burn can also be essential to optimize the functioning of a blockchain. If Ethereum did not perform this token burning, there was a chance that transaction costs would remain high. This does not benefit Ethereum’s network as many end users were not happy with the high transaction fees charged by the network.

Slimcoin (SLM)

Slimcoin is a cryptocurrency that uses Proof-of-Burn as a consensus mechanism. Miners can burn tokens within the Slimcoin network to create blocks. By burning tokens, miners also have a chance to receive blocks for validation for at least a year. They can then make money from that.

There is no need to burn SLM tokens because the network also allows burning of BTC. However, this is not worth it for many miners because BTC is seen as an important investment vehicle.

Advantages of a symbolic burn

Enough talk about why a token burn is so useful and which projects use this technique in practice. To sum everything up, let’s look at the main benefits of a token burn.

  • Keep the value the same or increase it – A project wants as many people as possible to buy and keep their token, but for that the value must remain the same and even better, increase.
  • Building a community – A project can build a community by performing a token burn. The community gets the feeling that the developers want the best for the token holders.
  • Better operation – By burning tokens, a development team can effectively make the network and blockchain work better, without immediately having to make major changes to the blockchain code.

Disadvantages of a token burn

Of course, there are also disadvantages to token burns. The biggest downside is that assets are lost, which is a shame according to many people. Tokens can be worth a lot of money, making a token burn quickly an expensive operation. Just think of the token burn of 2 million ETH. Assuming that ETH had an average value of $1500 at the time, $3 billion was lost during this upgrade.

Conclusion

A symbolic burning can therefore be very useful. Sending tokens to a non-existent address will destroy them forever. No one can ever get to the burned tokens again.

Such token burning occurs when a project wants to increase the value of its cryptocurrency. A decrease in supply usually leads to an increase in price. Another reason for the token burning can be the function of the blockchain, for example in the case of Proof-of-Burn. This consensus mechanism allows miners to burn tokens, after which they can create blocks. Token burns also take place for network optimization, such as restoring mine balance or lowering transaction costs.

Well-known projects that have used a token burn are Slimcoin, Ethereum and Binance Coin. In the case of these projects, burning tokens has been beneficial.

Looking for more information or have questions about token burns or other crypto topics? Or would you like to meet other crypto enthusiasts? In our product’s free Discord channels Money Mastery from AllesOverCrypto you can ask questions and meet thousands of other crypto enthusiasts. Have other crypto-related questions? The easiest way is to look up your question in our FAQ. Another thing you can do is google your question + All about crypto. Please let us know what you think about this article.

Main photo by Yaran


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