Token burning: What is it and what is its purpose?

In the world of cryptocurrencies, “token burning” is a process that has gained increasing popularity and has sparked the curiosity of many investors and enthusiasts in the cryptocurrency space. This mechanism has a significant impact on the economics of a blockchain project, and understanding it is essential to understanding its operation and its implications. In this article, we will explore in detail what a token burn is, how it works, why they occur, the benefits they bring, and whether this practice is advantageous for investors.

What is a token burn?

A token burn, also known as token burning, is a process by which a certain amount of existing digital tokens are permanently removed from the total supply of a cryptocurrency or token. This deliberate reduction in circulating supply has a direct impact on the supply and demand for that token, which can influence its value in the market. An illustrative case of this process is that of Binance, a prominent cryptocurrency exchange house, which carries out the quarterly burning of a portion of its BNB (Binance Coins). Binance has made a commitment to burn 20% of its profits into BNB each quarter, and this resulting amount is returned to the platform, but only under specific circumstances. The main purpose of this strategy is to maintain the value of the BNB token at optimal levels for users who use it on the Binance platform. However, there are other reasons to carry out token burning, and the decision to do so will depend on the particular circumstances of each person or organization.

chart

BNB quarterly token burn history. Source: Binance.

How It Works

The token burning process is usually carried out by the creators of a cryptocurrency or blockchain project. In general, it works as follows:

  1. Determination of the amount to burn: The project developers choose a specific number of tokens to be permanently removed from the supply. This amount may be fixed or depend on certain events or conditions.
  2. Execution of burning: Once the amount is determined, the selected tokens are sent to a smart contract address or wallet that is inaccessible, ensuring that they cannot be recovered or used again.
  3. Confirmation of burning: Most blockchains are transparent, meaning any user can verify token burning through the public transaction log. This provides a high degree of confidence in the process.
diagram f

How a token burn works. Source: WazirX.

Why do token burns occur?

There are several reasons why cryptocurrency projects may choose to conduct a token burn:

  1. Reduction of inflation: By reducing the circulating supply of tokens, inflation is decreased, which can contribute to price stability and prevent excessive devaluation of the cryptocurrency.
  2. Demand stimulus: By reducing the supply of tokens, perceived scarcity can be increased, often resulting in an increase in demand and consequently an increase in price.
  3. Reward investors: By removing tokens, projects can reward existing investors by increasing the value of their remaining holdings.
  4. Remove unused tokens: In some cases, projects may burn tokens that have become dormant or are considered “dead” to clean up the supply and increase the efficiency of the cryptocurrency.
  5. Comply with regulations: At times, token burns can be used to comply with local regulations or change the structure of a token to comply with legal requirements.
scheme

Different token burning catalysts. Source: ZipMex.

Benefits of burning tokens

Token burning can have several benefits for cryptocurrency projects and their investors:

  1. Perceived shortage: Reduced supply can increase perceived scarcity, which can attract investors and increase demand.
  2. Price stability: By reducing inflation and increasing demand, token burning can contribute to greater price stability.
  3. Investor Rewards: Existing investors often benefit from seeing an increase in the value of their remaining holdings.
  4. Efficiency improvement: By removing inactive or redundant tokens, projects can optimize their structure and operation.
diagram

Token burning, supply growth and ETH token issuance statistics. Source: Ultra Sound Money.

Is token burning good for investors?

The answer to this question depends on several factors, including the number of tokens burned, the purpose of the burn, and market conditions. Generally, a token burn can increase the value of the remaining tokens, benefiting existing investors. However, it is important to remember that the cryptocurrency market is highly volatile, and prices can fluctuate significantly. It is essential to research and understand the reasons behind a token burn before considering it as a deciding factor for investing in a project. Token burning is a powerful tool, but it does not automatically guarantee the success of a project or a profitable investment.


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