Token Burning: Explained

Elizabeth Wright
| Editor:
July 2, 2023
4 min read

What is token burning

Token burning describes the elimination of particular existing cryptocurrency coins from circulation or distribution. The “burning” of the cryptocurrency coins involves sending the tokens to an inaccessible address or address that is not managed or controlled by any individual. In most cases, the address is unavailable, and it makes it entirely unusable. In essence, when the coins are burned, it is similar to what occurs when a person sends a cryptocurrency coin to a non-existent address. The token will be entirely lost in cyberspace and can never be used. It is important to note that the burning can only be done by the person who issued the cryptocurrency and can only involve the tokens that are currently held by the issuer.

Token burning can occur after an initial coin offering (ICO). At the beginning of an ICO, the issuer defines the number of tokens that they intend to sell. However, they may be unable to sell all the tokens that were made available to investors. In this situation, they will burn the remaining tokens. After the cryptocurrency is burned, there is a need for a Proof of Burn. The blockchain process is entirely transparent, and any person can confirm that token burning has occurred by using a transaction ID (TXID) and check out if burning occurred. Transaction ID (TXID) is also called a transaction hash and is used to identify transactions on the blockchain. It identifies cryptocurrency transactions. The process ensures that there is no potential use of burned cryptocurrencies. The proof of burn guarantees that the token was burned and destroyed.

How does token burning work

There are four main steps when burning tokens. The first step involves the coin holder calling the burn function and stating that they want to burn a specific number of coins. The second step requires verification. A contract verifies if that coin holder has the particular number of coins in their wallets and that the number of coins mentioned is valid. It is important to note that only positive numbers work. If the coin holder does not have the stated number of coins or if the mentioned number is invalid, the burn function will not occur. If the person has enough coins, the indicated amount of coins will be subtracted from the coin holder’s wallet. The tokens will be burned, and a new number of coins will be updated in the coin holder’s wallet.

Notably, the burn function is permanent, and the coins are destroyed forever. Coin recovery is impossible after they are burned. The burn function is available to any coin holder at any time, and the feature can permanently remove a specific number of coins from circulation. The burning process is transparent and is recorded as a transaction using the TXID. As mentioned earlier, anyone can access the proof of burn through TXID to confirm that burning occurred.

In other situations, miners could be paid transaction fees to maintain the cryptocurrency network using their nodes. Other coins burn a small amount of each token that is transacted to improve the token’s value. It may also work as an incentive for people to invest in a project. Also, it has become a norm for companies to assure investors that the unsold tokens will be burned after an ICO.

Why do companies burn tokens

The main reason for burning cryptocurrencies is to improve the value of other coins that are still in circulation. Most coins have a finite and specific total number of coins that should be in circulation. If the demand for a particular coins remains constant, the value of the coins should increase because the supply is limited. The notion is derived from the law of demand and supply. If there are fewer coins to satisfy the overall market, the currency will become more valuable and desirable. Increased demand and a limited supply are noted by a constant increase in the cryptocurrency price. However, companies should realize that token burning is not a guarantee that the price of the remaining coins will improve. Regardless of the number of coins in circulation, the value of cryptocurrency coins is determined by demand and supply, or the amount of money that investors can pay for a coin. Some companies can also buy back tokens that are in circulation and burn them. Such a move can increase the value of coins held by investors, and it would reward their investment and faith.

On April 30, 2019, Atomic Wallet (AWC) burned 50000000 coins or half of its coin supply on the Ethereum blockchain, and a similar amount was later released on Binance DEX. The move allowed AWC to migrate to Binance Chain. Atomic stated that they would provide full support for BNB (BNB) and Binance Chain. However, coin holders can swap between the two chains. AWC uses the ERC-20AWC token standard, while the Binance chain uses the BEP2 token standard. AWC’s exchange partner, ChangeNOW manages the swap process. Clients can easily swap between the two standards and back in a few minutes without a hassle. You can swap from ERC-20 to BNB at a rate of 1:1 at ChangeNOW.

Other implementations for token Burning

Other than improving the value of the existing coins, token burning can be used to eliminate unsold coins after an ICO. As mentioned earlier, the number of coins sold is limited. The unsold coins can be sold at a profit, but a better scenario involves burning the unsold tokens. After burning the unsold coins, a company improves investor confidence that the company will only use the funds raised from the ICO. Also, it is beneficial to negate claims that a project could be a scam.

Token burning may occur to provide dividends. If a particular project provides a security token, it may convert investors into shareholders who are eligible for dividends. The tokens can be repurchased and burned. The value of the remaining tokens increases because of the artificial deficit that makes the coin more desirable and attractive for trading. Also, other than paying dividends directly to the shareholders, a company may reward shareholders by improving the value of their coins. In some situations, a company develops a program that obligates them to buy back a specific number of tokens at the prevailing market price to improve shareholder value.

Token burning assists in error correction. In some situations, a company can make token errors that can be solved by burning. For instance, a project may issue an excessive amount of coins, issue tokens that are unfit for investment or trade, unplanned increase in the number of issued coins because of a technical error, or the development of an invalid address for accepting and storing funds. When an excessive amount of tokens are released into the public, it is essential to burn the coins before to avoid reducing the value of the existing coins. The burning process is straightforward because the surplus tokens are sent to a blocked or non-existent address to ensure the funds are not withdrawn.

Benefits for Token Holders

The main benefit of token burning is increasing the value of the remaining tokens. The lower the supply of tokens on the exchanges, the higher the value of the existing tokens. The value of tokens is highly dependent on demand and supply. As mentioned earlier, most projects or cryptocurrencies have a limited number of tokens. Nevertheless, the crypto-market is highly volatile, and reducing the number of available coins is beneficial to investors so that it does not strain the entire market. For instance, Binance burns various coins every quarter. Burning the tokens ensures that the company minimizes the long term demand for the remaining coins and making it attractive for investors in the long term.

For instance, Eidoo decided to burn unsold tokens after its ICO. After the tokens began generating revenue, they continued burning the existing coins. The company burned about over nine million tokens, and it increased the value of the remaining tokens. It also burned one percent of its current supply of coins. It caused a 40% increase in the value of its coins after the announcement.

All in all, token burning creates scarcity that influences market capitalization. Also, Eidoo has a plan of buying back and destroying 50% of the tokens earned from its services fees, such as the revenues generated from its ICO engine. The process will assist Eidoo to decrease the total supply of tokens. The more its service is used, the more coins that will be burned. The main objective is to improve investor value.

In July 2018, Binance burned 2.5 million BNB tokens, whose value was worth $30 million. Binance has been aggressive in burning tokens, and they have an objective of burning 50% of the BNB supply. Token burning has also helped in increasing the number of users on its Binance platform. Increasing the number of investors will increase the demand for the remaining BNB tokens and their value. Other companies, such as KuCoin, are using 10% of their annual profits to buy back and burn its tokens to reduce the supply. However, there are concerns about whether buying back and burning tokens will be sustainable in the long term. The US Securities and Exchange Commission (SEC) stated that buying back tokens could derive the managerial and entrepreneurial efforts of other investors.

It is highly likely that the buyback and burn process could become a de-facto standard and diligent approach in future ICOs if the process is implemented honestly and reasonably. Future ICOs may be built on internal disinflationary methods to improve token prices, such as buybacks and burning. Also, there could be special loyalty programs to encourage coin holders to hold on to their coins for a longer time. However, some companies maintain market rumors that tokens will be burned. All in all, token burning could be described as a form of price manipulation that creates artificial scarcity to improve the value of coins.

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