What is a token burn?

In the realm of cryptocurrencies, where innovation and technology converge to redefine our relationship with money and investment, a concept both simple and deeply strategic emerges: the Burn.

What exactly is a burn?

In crypto, the term “burn” refers to the deliberate destruction of a certain quantity of cryptocurrency tokens in a permanent manner. Consequently, a burn reduces the circulating supply of the cryptocurrency since the total number of available tokens decreases.

Far from being a purposeless destruction, the burn is part of an economic strategy aimed at controlling the circulating supply and, potentially, increasing the value of the remaining amount.

However, it should be noted that a burn does not literally imply the destruction of tokens; it is merely figurative. Indeed, the process by which the tokens are burned involves sending them to a “dead wallet.” The particularity of such a wallet lies in the absence of a private key, meaning that it is impossible to access, thus remaining inactive forever.

Why Burn Tokens?

There are several reasons to burn tokens, including:

• Inflation Control: One of the primary purposes of token burning is to control inflation within a cryptocurrency ecosystem. By reducing the circulating supply, burning can help maintain the value of the remaining tokens, preventing devaluation due to an oversupply.
• Promotion of Scarcity: Scarcity is a fundamental economic principle that influences value. By deliberately reducing the number of tokens in circulation, burning helps create a perception of scarcity, thus increasing demand and potentially the value of the remaining tokens.
• Rewarding Holders: Burning can reward token holders by increasing the value of the tokens they own. As the supply decreases, if demand remains constant or increases, the value of the circulating tokens tends to rise, thereby directly benefiting the holders.

Burning is an economic strategy that allows cryptocurrency projects to actively manage their token supply, control inflation, promote scarcity, and enhance the investment value for holders. This practice demonstrates the ability of blockchain projects to use innovative economic mechanisms to regulate their market and foster growth and stability in their value.

Methods of Token Burning

Token burning in the cryptocurrency ecosystem can be conducted in several ways, each with its own advantages and disadvantages. Three main techniques are distinguished: using smart contracts, buyback before destruction, and direct destruction. Here’s an overview of these methods:

1. Buyback and Destruction

This technique involves buying back tokens from the market before destroying them. Tokens are often purchased with the profits of the business or project, then sent to a destruction address.

• Advantages:
  • Price Support: Buying back tokens can support their market price by creating artificial demand.
  • Flexibility: Projects can adjust the buyback volume based on their economic goals and market health.
• Disadvantages:
  • Financial Cost: Buying back tokens represents a direct cost to the project or business.
  • Risks of Manipulation: If poorly managed, buyback can lead to short-term price manipulations.

2. Automated Destruction

This method involves sending tokens to a smart contract address designed to “burn” them. These contracts are programmed to irreversibly remove tokens from circulation, ensuring they cannot be recovered or reused.

• Advantages:
  • Automation: The process can be fully automated and executed at regular intervals or under certain conditions, increasing transparency.
  • Security: Smart contracts reduce the risk of human error or fraudulent manipulation.
• Disadvantages:
  • Technical Complexity: Setting up smart contracts for burning requires specific technical expertise.
  • Transaction Costs: Executing burns via smart contract can incur transaction fees (gas fees) on the concerned blockchain.

3. Manual Destruction

Direct destruction involves sending tokens to a blockchain address specifically designed to be unusable, thus permanently withdrawing them from circulation without intermediary steps like buyback.

• Advantages:
  • Simplicity: The method is simple to execute, not requiring complex structures for implementation.
  • Efficiency: The act of burning by this method is definitive, ensuring a direct and immediate reduction in the token supply.
• Disadvantages:
  • Lack of Flexibility: Once tokens are destroyed by this method, it is impossible to recover them, limiting the ability to readjust based on future project needs.
  • Transparency: The main difference with smart contracts lies in the automation and programming of specific burn conditions that can offer an additional layer of transparency and trust compared to a simple destruction transaction.

Concrete Examples

To illustrate the impact of burn mechanisms on the economy of cryptocurrencies, let’s examine two notable cases: Binance Coin (BNB) and Ethereum (ETH).

Binance Coin (BNB)

Binance, one of the largest cryptocurrency exchange platforms in the world, has incorporated the burn process into the economic strategy of its native token, BNB. At regular intervals, Binance uses a portion of its profits to buy back and “burn” BNB, thereby reducing the circulating supply. This burn policy is transparent, with periodic reports published to inform the community of the number of tokens removed.

Ethereum (ETH)

Ethereum introduced a burn mechanism with EIP-1559, a significant update implemented during the transition to Ethereum 2.0. This update changes how transaction fees are handled by burning a portion of the fees instead of paying them to miners. The goal is to make transaction fees more predictable and to reduce the inflation of ETH.

This has had a direct impact since the implementation of EIP-1559, as a significant amount of ETH has been removed from circulation, creating a deflationary effect on the overall supply of ETH. Although the impact on the price is not immediate or direct, this approach contributes to the long-term scarcity of ETH and can support its market value.

Conclusion

Token burning, now a common practice in the cryptocurrency ecosystem, proves to be a powerful economic lever for projects looking to control their supply and increase the value of their digital assets. Whether through automated smart contracts or direct destruction, this strategy enhances transparency and investor confidence, while significantly adjusting the supply-demand dynamics.

The examples of Binance Coin (BNB) and Ethereum (ETH) perfectly illustrate how burning can be effectively integrated into the economic policy of a cryptocurrency, demonstrating its positive impact on token valuation. In conclusion, burning positions itself as a strategic tool indispensable for the management and enhancement of projects in the field of cryptocurrencies.