In this article, we will briefly explain what token burning means, how it works, and why companies do this.
What Is Token Burning?
Token burning is the process through which coins are purposely and permanently removed from the circulating supply.
It is typically performed by the development team behind a specific cryptocurrency asset and done in different ways.
The company burns parts of the supply that is already available to them, such as unallocated tokens or those that are stored in the team’s wallet or Treasury. It can also buy back tokens and burn them.
Some companies burn tokens regularly, while others do so as a one-off event.
For example, if there are any tokens left after a fundraiser is completed, the company may choose to burn them.
How Does Token Burning Work?
Tokens are burned in various ways:
1. Sending tokens to a frozen address, also known as “burn address.”
Nobody has the private key for this address. Once the tokens are sent, the transaction cannot be reversed, and they cannot be withdrawn.
An example of a common burn address is Ethereum 0x0, which contains more than $900 million worth of ERC-20 tokens.
2. Using the burn function that is included in the smart contract that issued the token.
For example, Binance carries out regular Quarterly Burns and has committed to reaching 100 million burned BNB tokens.
Reasons and Use Cases for Coin Burning
There are various reasons for token burning:
- Deflationary purposes – used to influence the price of a coin. If the supply is reduced and the demand remains the same or increases, the price goes up. However, if the demand decreases, coin burning may not help much.
- To maintain the price peg of stablecoins – here coins are burned to keep the price of an asset at a near-constant level.
- Correction – this enables a project to correct a mistake. For example, Tether created $5B in USDT by accident. These tokens had to be burned to prevent the new supply from destabilizing the 1:1 peg with the US dollar.
- To incentivize token holders – as a coin becomes more valuable, holders are incentivized to keep them. To achieve this, exchanges like Binance, KuCoin, Huobi, and OKEx burn tokens periodically.
- Effective consensus mechanism – the proof-of-burn mechanism is a consensus algorithm implemented by a blockchain network. It is used for validating transactions on the blockchain.
The most well-known benefit of token burning is an increase in the value of a coin, even only in the short term.
From the community’s angle, token burns can also be seen as a form of an airdrop since the value of a token may increase as a result.