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With many cryptocurrencies, the number of circulating tokens increases over time. Consider, for example, Bitcoin (BTC), where the last cryptocurrency is expected to enter into circulation in 2140. Other projects, on the other hand, are busy lowering the number of circulating tokens. They do this by means of a token burn.
Token burns take place on the blockchain and ensure that tokens are released from circulation. Any blockchain could perform such a token burn, driven 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 that projects burn their own tokens.
In the event of a token burn, tokens are removed from circulation. Every cryptocurrency has a certain number of cryptocurrencies in circulation, part of the tokenomics. Increasing the number of circulating tokens is quite easy, because you can create new tokens for that. However, withdrawing tokens from circulation is a lot more difficult. It’s not a matter of adjusting a number. No, they have to burn the tokens for that.
A token burn occurs by sending the tokens to a non-existent or wrong 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 come into circulation again.
Of course, that does not mean that the number of circulating tokens cannot grow after a token burn. The developers or the community can easily create new tokens for this.
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.
Every 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 linked to a wallet address. When the wallet address wants to access its tokens, the computers in the blockchain can immediately see which tokens are linked to the wallet address.
With a token burn, the tokens are linked to a wallet address that is wrong or does not exist. Because no one can own this wallet address, no one can ever gain access to 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 destroyed tokens are linked.
This also means that the tokens do not actually ‘disappear’. They still exist, more can never be sent.
You can also easily burn tokens yourself by sending them to a non-existent address. By the way, do not try this out, because it is impossible to get the tokens back. After all, the blockchain has no customer service that can help you with this. That is why it is also important to always check the wallet address carefully when sending tokens to other users.
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 terms.
Maximum supply 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 supply is the maximum supply minus the number of tokens one has burned. These tokens will not be released anymore, and therefore they are not seen as part of the circulating supply.
Circulating supply is the number of tokens currently tradable. This number can always increase as the project may release new tokens in the future.
Burning tokens may sound weird: why would you do that? Yet 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.
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 rises and supply falls or stays the same, the price is likely to rise. This is also the case when the fall in supply is greater than the fall in demand.
By taking tokens out of circulation, the supply is reduced. This can cause the price of the token to rise, although this is of course never a guarantee. There are also known cases of cryptocurrencies depreciating after the team decided to burn a large portion of the tokens.
A development team must have a good reason for a token burn, because otherwise this can cause people to lose faith in the project.
Proof-of-Burn is a consensus mechanism, just like Proof-of-Work and Proof-of-Stake. This mechanism is used to reach agreement 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 has to send tokens to a non-existent wallet address in order to show its bet to the network. The node is then allowed to validate transactions in order to earn money within the network of the blockchain.
When a new cryptocurrency is released from mining, the mining speed is reduced. The miners who have been active for a longer period of time can gain an unfair advantage over new miners. In that case, new miners hardly get a chance. Therefore, developers can choose to burn tokens so that the number of circulating tokens decreases or stays the same. This gives new miners a chance to make money within the network.
This also contributes to the decentralization of the network. When it is attractive for new miners to set up 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 these same nodes.
Enough reasons to burn tokens! Yet you don’t hear about it very often in practice. However, there are several projects that are concerned with burning tokens. Below you can see a number of examples of token burns in practice.
The most famous example is probably the Binance Coin, which runs on the Binance Smart Chain (BSC). An auto-burn is programmed within the protocol. With this, crypto exchange Binance, the maker of the 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 part of the profit made. Then these tokens are automatically burned by sending them to non-existent addresses.
During the upgrade to Ethereum 2.0, a token burn occurred within 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.
During this token burn, at least 2 million ETH tokens were lost. After that, more tokens were burned. This shows that a token burn can also be essential to optimize the functioning of a blockchain. If Ethereum did not execute this token burn, there was a chance that transaction costs would remain high. This does not benefit Ethereum’s network, as many end users were not satisfied with the high transaction fees charged by the network.
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 earn money with this.
It is not necessary to burn SLM tokens, because the network also allows the burning of BTC. Yet this is not worth it for many miners because BTC is seen as an important investment vehicle.
Enough talk about why a token burn is so useful and which projects use this technique in practice. To summarize everything, let’s look at the most important benefits of a token burn.
There are of course also disadvantages of token burns. The main disadvantage is that assets are lost, and that 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 ETH had an average value of $1500 at the time, $3 billion was lost during that upgrade.
A token burn can therefore be extremely useful. Sending tokens to a non-existent address will destroy them forever. No one can ever get to the burned tokens again.
Such a token burn 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 burn can be the functioning of the blockchain, in the case of Proof-of-Burn for example. 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 the mining balance or lowering transaction costs.
Well-known projects that have applied a token burn are Slimcoin, Ethereum and Binance Coin. In the case of these projects, burning tokens has been beneficial.
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