What Does Burning Crypto Mean?

When a cryptocurrency community decides that they want or need to destroy units of a specific cryptocurrency, they use a process called coin burning. Burning crypto is the process that effectively takes those tokens out of circulation, reducing the total supply of that coin and, in some cases, increasing demand.

A crypto coin burn is similar to a stock buyback. That’s when the company that issued the stock buys back several shares and reduces the total number of shares on the market.

While a coin burn can bump up the value of a particular cryptocurrency, there are no guarantees that this process will increase the price or (if it does) that the price won’t decline. There are several other reasons developers might choose to burn coins.

What Is Crypto Burning?

So, what does burning crypto mean, given that all “coins” are digital and exist via blockchain technology?

First, think about how crypto gets bought and sold. Traders can exchange crypto by sending it to and from a crypto wallet using their private keys. To execute a coin burn, users send their crypto to an “eater address” or a burning wallet, a crypto wallet that only receives tokens but can’t send them. Thus those coins are effectively locked up and taken out of circulation.

That transaction, confirmed on the blockchain ledger, makes the coin burn permanent and irrevocable.

6 Reasons for Burning Crypto

There are a few reasons why different cryptocurrencies might want to burn coins. Some projects include this process from the beginning as part of the protocol itself, while others choose to take it on in some form later down the line.

With the rise of decentralized finance (DeFi) protocols, coin burning has become more common. Here are some cases when coin burning makes sense.

1. As a Consensus Mechanism

Some coins use proof-of-burn (PoB) as a consensus mechanism on the network. This requires both miners and users to burn some of their coins regularly. Proponents of this method consider it an efficient way of verifying transactions because it does not use real-world resources.

There are several specific methods of using this consensus mechanism, such as:

•   In a PoB network, miners must burn some of their coins to mine new blocks. It sounds counter-intuitive, but miners then receive rewards in the form of new coins when they verify a new block of transactions.

•   Some coins require burning a different cryptocurrency in exchange for new tokens on the new network. Miners might have to burn Bitcoin, for example, to earn another coin.

•   Some blockchains use more complex forms of PoB, such as burning native tokens in exchange for credits. Holders can then use those credits to perform a function on the blockchain. Sometimes this involves the constant minting of new coins and the burning of a portion of the coins.

2. To Protect Against Spam

Coin burning can help protect a network from Distributed Denial-of-Service Attacks (DDoS) and stop spam transactions from slowing down the network. Here’s how: Just as Bitcoin users pay a small fee for sending transactions, or Ethereum users pay a gas fee for smart contract computations, some networks require that miners/validators burn the fees they get for transactions.

This mechanism can automatically burn a part of each transaction that gets sent. Ripple (XRP), for example, uses this method.

3. To Increase a Coin’s Value

The fundamental economic law of supply and demand dictates that if the supply of something decreases, then the price will have to rise, assuming demand remains constant. This is partly because Satoshi Nakamoto (the pseudonym used by the person or people who created Bitcoin) programmed the Bitcoin protocol to “halve” every four years, reducing the block reward for miners by 50%. Thus, fewer bitcoins enter circulation.

The destruction of coins can serve a similar purpose. Burning coins reduces the supply.

While fiat currencies are inflationary, and central banks can print them in unlimited amounts, some cryptocurrencies are deflationary and have fixed supply limits. Bitcoin has a supply limit of 21 million coins.

The more people who want to buy, hold or use Bitcoin, the faster the price will rise because there are only so many coins to go around. As long as the demand stays constant and the supply remains limited, the price of Bitcoin may keep rising compared to any fiat currency. Past performance, of course, is no guarantee of future results.

For other cryptocurrencies, engaging in coin burning can sometimes be an effort to manage supply in a way that increases scarcity and tries to mimic Bitcoin’s supply and demand dynamics.

4. To Keep Stablecoins Stable

Coin burns can be necessary in the case of stablecoins because burning a particular portion of the supply can help the stablecoin stay pegged to its fiat currency (like the dollar).

For example, suppose the demand for a stablecoin rises, and the price goes above its dollar peg. In that case, the protocol’s smart contract will automatically issue new tokens to bring the price down — or burn coins to drive the price up, so its dollar peg remains constant.

5. As a Sign of Long-Term Commitment

The owners of a crypto project sometimes burn coins on their network as a show of commitment toward scarcity. Maintaining a certain degree of scarcity (see Bitcoin, with its 21 million caps) makes everyone holding those coins a little richer. Owners may accomplish this through a burn mechanism, providing periodic burn schedules, or as a one-off event.

Some investors view this strategy as a way to keep a coin’s value growing; thus, it may help investors feel more confident about staying invested over the long term.

6. To Promote Mining Balance

In some cases, the PoB system can establish the burning of crypto on a regular cadence that helps maintain a balance between new users and early arrivals — e.g., the first and sometimes the most prominent investors on that platform.

That’s because the PoB consensus mechanism, which requires burning coins to validate transactions, helps to stimulate the mining of new coins. So this permits a balance between the new users and the old guard.

Pros and Cons of Burning Crypto

Crypto burning has some upsides for the platform and specific users, but as more projects embark on coin burnings, it pays to keep the downside in mind.

Pros of Burning Crypto

•   Coin burning may enhance a crypto’s value by limiting the supply. An uptick in price isn’t guaranteed from a coin burn, but it has happened — although a drop can also follow.

•   Burning coins can help control inflation for a particular crypto, e.g., stablecoins.

•   Using proof-of-burn as a consensus mechanism is a low-energy way to validate transactions and create new coins while keeping the supply in balance.

•   Related to the above, proof-of-burn can help protect the network from being hacked.

Cons of Burning Crypto

•   A coin burning may have little or no impact on long-term price.

•   Sometimes, a coin burning can be faked, and developers use the “burn” to send coins to their address.

•   Rather than decreasing supply and increasing demand, sometimes burning coins can turn investors off if they feel manipulated or lose confidence in the project.

Different Types of Coin Burning

Coin burning typically falls into one of three categories:

1. Coin Burning at the Protocol Level

The proof-of-burn consensus algorithm discussed earlier falls into the first category. Blockchains that use PoB have coin burning built into their protocols. This means burning is an intrinsic part of the network and takes place consistently so long as the coin continues to function.

Using coin burning as a spam-protection mechanism can also occur at the protocol level. As mentioned earlier, transactions must have a cost to prevent the network from being spammed with fake transactions. One way to accomplish this is automatically burning a portion of each transaction fee.

2. Coin Burning as Economic Policy

The second category involves developers who might decide to burn coins to control the supply of coins to manage inflation.

One example might be the deliberate destruction of unsold ICO tokens. The creators of a new project might have created X number of coins hoping to sell them all but failed to meet this objective. In such a scenario, the developers could burn excess coins to maintain a specific supply level.

3. Coin Burning in place of Dividends

Some projects might also use coin burning as a dividend payment to coin holders. If the token owners have a business that generates cash flows, like a crypto exchange, token holders could receive rewards through coin burning.

In a boon to those who’ve chosen a HODL strategy, the owners could buy back tokens from holders and burn those coins, thereby increasing the value of everyone’s crypto. This might occur instead of traditional dividends, which might trigger securities regulations. The burn process could occur as a one-time or regularly scheduled event.

History of Crypto Burns

As noted above, burning coins to limit the supply and increase demand likely comes from the long-standing Wall Street tradition of stock buybacks to improve share prices and reward shareholders. In the case of crypto coin burns, the reasons can be more complex.

Different Reasons for Burning Crypto

These days there’s nothing unusual about a coin burn. And there have been several well-known coin burns, generally starting in 2017. Some were at the protocol level (meaning the burn or burns were built into the project itself), and some were executed to limit supply and raise cash — or in place of dividends (as noted above).

•   In 2017, for example, Binance Coin (BNB) began its series of quarterly burns. BNB launched with a 200,000,000 total supply and will continue on its burn schedule until 100,000,000 coins are burned — or 50% of all BNB in circulation. BNB’s 20th burn occurred on July 13, 2022.

•   By contrast, Bitcoin Cash (BCH) had a coin burn in 2018 that drove up the price temporarily. And Stellar (XLM) held a one-time burn of 50% of its supply in November 2019. This was intended to limit the number of coins and increase demand.

•   More recently, Ethereum made headlines when the platform burned more than 2 million of its Ether tokens in March 2022: The burn was worth nearly $5.8 billion. This burn was automated, however, as part of an earlier fork of the Ethereum blockchain that laid the stage for this coin burn: EIP-1559.

The Increase in Coin Burning

While some view burnings with a skeptical eye, there’s no arguing that this strategy has become more popular — particularly for new crypto that launch with a big supply.

One tactic an investor will note is that new crypto might launch with upwards of a billion or even a trillion coins, typically worth a fraction of a penny, to burn some of that excess supply later to drive up prices.

Shiba Inu Coin Burn

The case of Shiba Inu’s burn strategy, or burn controversy, is an excellent example of how some platforms try to manage a vast circulating supply, a meager price, and investors eager for profit.

Shiba Inu (SHIB) is worth $0.000019 as of August 3, 2022, with a total supply of about 549 trillion SHIB. The coin burn conducted at the end of July 2022 only burned about $13,500 worth of SHIB, or 0.0002% of its supply.

While SHIB has a loyal cadre of investors, some question the merits of the SHIB coin burning.

Cryptocurrency Investing Today

Burning coins involves taking them out of circulation and destroying them forever, permanently reducing the available supply of that token. The exact reasons for doing this can vary, from platforms that essentially program coin burns into their protocol to crypto developers that want to see a price bump.

Although the crypto community generally views coin burns as more positive than negative, there is still a great deal of skepticism about coin burns. Different types of cryptocurrency use coin burning in different ways, and it’s essential to understand the approach of any crypto in which you’re considering investing.

FAQ

What are crypto burns?

Crypto burns, also known as coin burnings, are when a project decides to take a certain number of coins out of circulation.

Why do crypto burns take place?

There are several reasons. Two common ones: The coin burn is predetermined and part of the platform’s overall protocol. In another case, developers burn coins to limit supply and potentially increase demand. It’s a good idea to look into why a coin burn is happening to understand the impact on the crypto overall.

Can burning crypto increase its value?

Burning crypto might increase its value, but it’s not guaranteed it will. One thing that’s clear from looking at the performance of different coins after a burn: even if the price bumps up, there’s no guarantee it will stay there.

The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.

Investment decisions should be based on an individual’s financial needs, goals, and risk profile. ZP Enterprises can’t guarantee future financial performance.