Token burning.
Key Takeaways
- Token burning removes tokens from circulation by sending them to a wallet address that can’t be accessed.
- Token burning is a strategy to decrease the number of available tokens, which can make the remaining tokens more valuable due to scarcity.
- While token burning can increase demand and raise prices, it does not always bring positive results.
- Binance Coin (BNB), Ripple’s XRP, and Ethereum have each used token burning in different ways to control their supplies and manage their economies.
In 2021, Vitalik Buterin, co-founder of Ethereum, destroyed almost half of all SHIB tokens, totaling around 410 trillion. This is one of the major cases of token burning, yet such practices occur regularly.
Since token value is a primary driver in the crypto industry, why is token burning so widespread?
The article explains what it means to burn crypto, detailing how it works and its benefits and risks, and includes comparisons and examples.
Token Burning Explained
In the crypto industry, token burning is a process that removes tokens from circulation by sending them to an inaccessible “burn address,” where private keys cannot be obtained. This is akin to destroying money, thus the term “burning.” However, burning tokens can serve many purposes.
The concept is based on a simple tokenomics principle: reducing the supply increases demand and the value of the tokens, potentially leading to a higher price. However, burning tokens does not guarantee a price increase, as it also depends on factors such as the project’s performance, investors’ sentiment, and general market conditions.
Additionally, token burning can serve many other purposes, which will be covered.
How Token Burning Works
Let’s understand token burning using BNB as an example.
Binance runs regular quarterly burns of its Binance Coin (BNB), using a portion of its profits to buy back tokens from the market. These purchased tokens are then sent to a burn address, and they are removed from circulation. As a result, Binance reduces the total supply of BNB, which can potentially increase its value by making the remaining tokens more scarce.
This practice aims to align the interests of the BNB users and holders with the growth of the exchange, potentially increasing the token’s demand and price as the exchange’s volume and profitability grow.
Benefits Of Token Burning
Token burning can significantly impact the economy of a cryptocurrency by affecting supply and market dynamics. A few of their benefits are the following:
- Decreased supply: Reducing the total amount of tokens can create a scarcity effect.
- Potential increase in token value: If demand remains steady or increases, the reduced supply can lead to a higher price per token, benefiting holders. This outcome aligns with the basic economic principle of supply and demand.
- Deflationary pressure: Unlike fiat currencies that often follow an inflationary model, the value of remaining tokens may increase over time since no more can be created, setting a deflationary trend in the market.
Risks Associated With Token Burning
As previously seen, token burning can offer potential benefits. However, it can also come with some risks that stakeholders should consider. For example:
- Potential negative impact on liquidity: By reducing the number of tokens in circulation, burning can decrease liquidity. This reduction might make it harder for holders to buy or sell large amounts of tokens without affecting the price, which can be particularly problematic in smaller or less active markets.
- Manipulation concerns: Developers or large holders can sometimes use burning tokens to artificially manipulate market perceptions. Announcing burns can lead to temporary price spikes as investors rush to buy tokens, which might benefit insiders who sell during these periods.
- Long-term effects: While the immediate effect of a token burn might be positive, the long-term impact on the token economy is uncertain.
What Is The Difference Between Token Burning And Buybacks
Token burning and buybacks are two financial strategies cryptocurrency projects and companies use to manage their token or stock supply. Each has distinct mechanisms and goals. Understanding the differences between these strategies can offer insight into how organizations aim to increase value for their stakeholders.
Token burning and buybacks are financial strategies designed to shape token supply and increase token value, but they differ significantly in their mechanisms and specific goals. Token burning permanently removes tokens from circulation by sending them to an irretrievable address, effectively destroying them.
On the other hand, buybacks involve a project purchasing its own tokens, held in the project’s treasury, and may be reintroduced into the market later.
| Aspect | Token burning | Buybacks |
|---|---|---|
| Definition | Remove tokens to an unreachable address. | Buy back, hold, reissue, or retire tokens. |
| Purpose | Permanently reduce total supply. | Temporarily or permanently reduce supply. |
| Impact on supply | Always decreases total supply. | May reduce supply temporarily or permanently. |
| Financial impact | No direct return; speculative value. | Immediate financial benefits possible. |
| Market perception | Seen as long-term value commitment. | Viewed as positive for undervalued stock. |
Examples Of Token Burning
Token burning is a prevalent strategy among various projects, with some instances proving more notable than others.
From major exchanges employing quarterly burns to enhance investor confidence to memecoins and non-fungible tokens (NFT) projects using initiatives aimed to increase scarcity, token burning reflects its significance in the strategic management of blockchain ecosystems.
- Binance Coin (BNB): This is one of the largest cryptocurrency exchanges and conducts quarterly burns of its Binance Coin (BNB). These burns are part of a commitment to reduce the total supply of BNB by 50%, from 200 million to 100 million tokens. Binance uses a portion of its profits to buy back and burn BNB.
- Ripple’s (XRP) ledger: Ripple initially set the supply of XRP tokens at 100 billion. Although Ripple hasn’t engaged in large-scale burns like other projects, the XRP Ledger uses a small amount of XRP as a transaction fee, which is burned. This mechanism incrementally reduces the total supply of XRP over time.
- Stellar (XLM): In November 2019, the Stellar Development Foundation burned close to 50% of the total XLM supply, removing about 50 billion XLM from the 105 billion initially in existence. This decision aimed to make the existing circulation more in line with what the network needed, intending to enhance the overall value of the token.
- PancakeSwap (CAKE): As a decentralized finance (DeFi) application, PancakeSwap uses a portion of its transaction fees to buy back and burn its CAKE token. This regular burning mechanism is designed to continually reduce the supply, potentially increasing the token’s value as part of its economic strategy.
Conclusion
Token burning is a common strategy in the cryptocurrency world. It manages the supply and can potentially increase the value of tokens.
Major platforms like Binance use regular burns to increase the scarcity of their tokens and boost confidence among holders. Blockchains like Ethereum burn tokens to stabilize fees and reduce inflation. Although token burning can lead to higher prices and a deflationary effect, it also brings risks like lower liquidity and the possibility of market manipulation.
In contrast, buybacks can reintroduce tokens to the market, offering a different way to manage supply. While token burning can be a powerful tool to enhance token value and ensure a project’s longevity, it’s not universally favored and does not always bring the desired benefits.
FAQs
Token burning can significantly impact the overall cryptocurrency market by altering perceptions of scarcity and value. Token burning is generally legal and widely accepted as a legitimate practice within the cryptocurrency industry. Yes, a project can decide to stop token burning. The decision to initiate or cease token burning typically lies with the project’s developers or governance structure, depending on how they manage the project.How does token burning affect the overall cryptocurrency market?
Is token burning legal?
Can a project stop token burning?
