Learn Cryptocurrency
31 Mar 2022

Crypto Coin Burn: What and Why?

Devansh Sinhal

Crypto burning is one of the least understood concepts in this ecosystem. Considering how important burning is to many stablecoins, altcoins, and even Bitcoin, it’s not a bad idea to learn about the process, functionality, and utility of cryptocurrency burning. This quick read brings it all to your doorstep.

What is Coin Burning?

Coin Burning is the process by which existing crypto coins are sometimes removed from circulation. The relevant coins are sent to what is known as a burn address—a wallet from which they can never be recovered. This is also often seen as a way to “destroy” tokens, because they can no longer be used once they get there. These burn wallets are inaccessible to everyone, which means that their holdings can never be used in any transactions in the economy. Hence they are, for all practical purposes, non-existent.

Why are Tokens Usually Removed from Circulation?

Good question. The answer depends on the kind of token.

  • Stablecoins need constant burning to keep prices pegged to external assets. USDT, a stablecoin pegged to the US Dollar, has inbuilt algorithms that periodically burn existing tokens or mint new ones to adjust its price according to the dollar. That’s because:

Minting new coins increases supply, which decreases the price. Burning existing coins decreases supply, which increases prices.

  • Altcoins can also be burnt. They are frequently burnt to raise prices and bring scarcity in the market. Sometimes, they can also be used to transfer value. For instance, Terra’s project LUNA engaged in what was perhaps the biggest altcoin burn of all time—88.7 million LUNA tokens. These coins represented a combined value of more than $4.5 billion at the time. This was done to transfer value from LUNA’s community pool to individual holders and to keep prices up. A few days after the burn, the altcoin in question hit an all-time high.

Can All Coins Be Burnt, and Is Burning Necessary?

Since every coin can be sent to an irretrievable address, every cryptocurrency can be burnt. However, not all coins are usually burnt, and with the ones that do get burnt, it only takes place on specific occasions.

The decision regarding whether to burn coins differs a lot depending on the project’s short-term and long-term goals.

Coins are usually burnt by development teams to ensure that prices remain positive. By decreasing the supply of a certain asset in the market, burning sets a deflationary process in action, which drives prices up. Since this benefits individual token holders, burning is generally considered to be a positive event, because not doing so would mean that the prices will drop. So, to some extent, yes, coin burning is bound to happen periodically.

Do Prices Always Increase After a Burn?

Generally, yes, since burning causes a drastic decrease in the supply of the token in the market, prices usually shoot up.

This, however, isn’t necessarily the case for all projects. For coins that have scheduled burn timelines, investors already “price-in” the burn before the event actually occurs. This means that while the market did move because of the prospect of burning, it wasn’t a direct result of the process.

Coins that operate on a Proof-of-Stake (PoS) consensus mechanism can be staked to earn block rewards regularly. For instance, when PoS coins (that is, transactions are verified in the underlying blockchain by validators who are selected based on the size of their holdings) are burnt, the value of the existing stake increases automatically.

What is Proof-of-Burn?

A relatively new innovation that currently needs more research and development is called Proof-of-Burn (PoB). PoB, as the name suggests, is a consensus algorithm that’s based on the concept of token burning. In this system, miners have to burn tokens proportionate to the transactions they wish to verify and blocks they want to mine. The more coins they burn, the more they can verify transactions and earn rewards.

Because tokens are being continuously burnt, there’s also less competition in the market. Hence, tokens based on PoB don’t need an army of miners to secure the blockchain at all times.

Wrap-Up

Token burning, as a process, is great for the crypto ecosystem as a whole. Token burning reduces the inflationary nature of the asset while incentivizing investors to hold on to their tokens in the long term. And when more and more investors start holding their coins longer, stability ensues in the market and everyone benefits.

Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

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Devansh Sinhal

Content Writer

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