Contents:

Token Burning: Explained

By:
Elizabeth Wright
| Editor:
Paul Sazan
|
Updated:
August 2, 2024
|
4 min read

Token burning is like setting money on fire, but with a purpose. In the crypto world, it means deliberately destroying a chunk of tokens to reduce the total supply. Why? To make the remaining tokens more valuable by creating scarcity. Think of it as a way to keep inflation in check and make sure your digital coins hold their value over time.

Take Ethereum for example. In 2021, they introduced EIP-1559, which led to burning 1.3 million ETH. The goal? To turn ETH into a deflationary currency and boost its long-term value by cutting down its supply.

How Does Token Burning Work?

There are a few ways to burn tokens, each with the same goal: reducing supply. Here’s how it’s done:

  1. Transaction Fees: Some networks, like Ethereum, burn part of the transaction fees. With EIP-1559, a base fee gets burned for every transaction on the Ethereum network.
  2. Buyback and Burn: Here, the project team buys back tokens from the market using profits and then burns them. This shows they’re serious about boosting token value and can make investors feel more confident, it’s commonly used in Binance Coin
  3. Manual Burn: Tokens can be sent to a "burn address," which can only receive tokens but not send them. This makes the tokens disappear from circulation forever.
  4. Scheduled Burns: Some projects, like Ripple, have a set schedule for burning tokens, often laid out in their whitepaper. These burns happen at regular intervals.

This permanent reduction in supply can help stabilize the economy of the cryptocurrency and potentially increase its value over time. Token burning also 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. 

Knowing how token burning works can help you make smarter choices in the crypto market, whether you’re just starting out or you’ve been around the block a few times.

Examples of Token Burning

Token burning is like a digital bonfire for cryptocurrencies, where tokens are intentionally destroyed to reduce the total supply. This can make the remaining tokens more valuable. Let's check out how ETH and LUNA have used this tactic.

Ethereum and EIP-1559

In 2021, Ethereum shook things up with EIP-1559, a proposal that changed how transaction fees work. Part of the fees now get burned, meaning they're gone for good.

That year alone, around 1.3 million ETH went up in digital smoke. The goal? To make ETH a deflationary currency, which means fewer tokens over time, potentially boosting their value.

Burning ETH helps keep inflation in check and creates a more balanced economic scene for Ethereum users.

Terra and Recent Burn Events

Terra (LUNA) has also jumped on the burning bandwagon. In November 2021, they torched 88.7 million LUNA tokens. This wasn't just for show; it was a strategic move to control the token's supply and keep its value steady.

By cutting down the number of LUNA tokens in circulation, Terra aims to create scarcity, which can drive up the token's price.

So, whether it's Ethereum or Terra, token burning is a clever way to manage supply and potentially boost value. These examples show how burning tokens can help stabilize or even increase their worth by making them rarer.

Token Burning: What You Need to Know

Price Boost and Economic Impact

Token burning is like a magic trick for cryptocurrencies. By cutting down the number of tokens in circulation, the value of the remaining ones can go up, as long as people still want them or want them even more. This can lead to a price boost and a more stable economy for the crypto.

Another cool example is Olympus DAO's OHM. They use an algorithm to manage their token supply. If the price drops too low, the algorithm burns tokens to keep the price stable. This helps maintain a steady value, making it a safer bet for investors.

Burning tokens can also make a cryptocurrency more useful for transactions over time. By cutting down the supply, the token becomes rarer, which can boost investor confidence and interest.

The Dark Side: Risks and Controversies

Token burning isn't all sunshine and rainbows. There are some risks and controversies to watch out for. One big risk is manipulation. If the process isn't transparent, token burns can be used to artificially pump up prices or mislead investors about the actual supply.

Another issue is that once tokens are burned, they're gone for good. This can be a double-edged sword. While it ensures the supply is genuinely reduced, any mistakes or miscalculations can't be undone.

Regulatory scrutiny is another headache. Since token burning affects the supply and value of a cryptocurrency, it can attract the attention of regulatory bodies. Staying compliant with regulations and being transparent with the community are crucial to avoid trouble.

Lastly, the long-term economic effects of token burning are still a bit of a mystery. While reducing supply can create deflationary pressures, it can also lead to decreased liquidity. This makes it harder for users to buy or sell the token, which can lead to increased volatility and scare off investors.

In a nutshell, while token burning can offer big benefits like price boosts and economic stability, it also comes with a set of challenges and risks that need careful handling.

Token Burning: How to Do It Right

Token burning can be a game-changer for your cryptocurrency project, but you gotta play it smart. Let's break it down into two main parts: keeping things transparent and engaging with your community, and staying on top of the rules and what's coming next.

Keep It Clear and Involve the Community

If you're burning tokens, you need to be crystal clear about it. People need to know what's happening and why. Here's how to keep everyone in the loop:

  1. Tell Everyone What's Up: Before and after you burn tokens, make sure you announce it loud and clear. Share the details—how many tokens are going up in smoke, why you're doing it, and what it means for the token supply.
  2. Use Public Burn Wallets: Make sure everyone can see that the tokens are really gone. Public burn wallets are a must. This way, no one can accuse you of pulling a fast one.
  3. Keep the Updates Coming: Regular updates are key. Take a page from Binance's book—they're committed to burning half of their total supply and keep everyone posted with their Auto-Burn formula.
  4. Get the Community Involved: Use forums, social media, and live updates to keep the conversation going. Let people ask questions and share their thoughts. It builds trust and makes them feel like they're part of the process.

Follow the Rules and Look Ahead

Token burning isn't just about setting tokens on fire; you gotta play by the rules and keep an eye on what's next:

  1. Stay Legal: Make sure you're following all the laws, both local and international. This means keeping up with anti-money laundering and know your customer requirements.
  2. Document Everything: Keep a record of every burn event—why you did it, how you did it, and what happened. This is crucial for audits and regulatory checks.
  3. Watch the Trends: Stay updated on new trends and tech in token burning. Automated burn mechanisms, like Binance's Auto-Burn, can make the process more predictable and transparent.

By following these tips, you can burn tokens effectively while keeping things transparent, building community trust, and staying on the right side of the law.

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