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Token Burn Explained

Why Burn Cryptocurrencies?

The main reason for burning a cryptocurrency is to increase the value of the other tokens that are in circulation. Many cryptocurrencies have a finite total number that can exist and therefore, assuming the demand for the token remains the same, the value should theoretically go up if there are less in circulation. This idea stems from the notion that there are fewer tokens to satisfy the overall demand for that particular cryptocurrency making the one that do exist more desirable and therefore valuable. An increase in the demand for a cryptoasset can be noted by a consistent rise in the price of that particular token combined with growing volume.

Investors must be aware that burning a cryptocurrency is by no means a guarantee that the value of the remaining tokens will increase. Regardless of how many tokens there are, value is always dictated by supply and demand, or how much investors are willing to pay for a cryptocurrency. Just because there are less in circulation does not mean that potential buyers will be willing to pay more for those that still exist.

Following this logic, some cryptocurrency platforms will buy back the tokens that are already in circulation and burn them, rather than pay out dividends to holders in return for their investments. In theory, this should lead to an increase in the value of the tokens that the investors are already holding, rewarding them for their faith and investment.

A similar method can also be employed to pay transaction fees to the miners who maintain the network through their nodes. Certain cryptocurrencies will burn a miniscule amount of every amount that is transacted, which should marginally raise the value of that currency. However, when this is done on a large scale the transactors, and network as a whole, benefit from the usage of that particular cryptocurrency. So, instead of paying the transaction fee to a miner or any one party, the transactors pay the entire network.

The burn is carried out by the issuer of the cryptocurrency and will only involve the tokens that the issuer of that currency holds. Investors tokens are not at risk of being destroyed, it is only when paying transaction fees that a holders token are burned.

ICO Token Burn

An ICO will normally define the amount of tokens that it intends to sell before the sale begins. However, not all ICOs will necessarily sell all the tokens that they have made available to investors. In this scenario many ICOs will burn the unsold tokens. The alternative to this being that the founders keep the remaining tokens for themselves or possibly airdrop them. However, the disadvantage of doing so is that it could lower the value of the tokens that have been bought and are in circulation, especially the former which is also doing so to the sole benefit of the founders.

Burning cryptocurrencies is sometimes used as an incentive for investors to buy into a project. This means that tokens that are not held by the team or sold to investors will be destroyed and not reduce the value of those that are in circulation.

To avoid the negative publicity that doing so would cause, it has become a relatively common practise for an ICO to assure potential investors that it will burn any unsold tokens. It is advisable for any potential investor to check whether a project that they are considering investing in makes this assurance.

How are Cryptocurrencies Burned?

The “burning” of the cryptocurrency involves sending the tokens to an address that is not controlled or that cannot be accessed by anyone. Usually the address is invalid which makes it entirely unusable. In practise, what happens when a cryptocurrency is burned is similar to what would happens if an individual sends a cryptocurrency to an address that does not exist. The tokens are forever lost in cyberspace.

 

Equally, burning cryptocurrencies can allow for the creation of further tokens. Mining or forging can generate new tokens in the form of reward for the miners who are validating blocks of transactions. However, this inherently creates more tokens, which could theoretically reduce the value of those that are already in circulation. ICOs prepare for this circumstance by withholding tokens and burning them to ensure a consistent and stable supply of coins.

What is Proof of Burn?

Cryptocurrencies are burned by being sent to an invalid and verifiably useless address, in essence an address that cannot be accessed by anyone. Due to the transparent nature of blockchain anyone can confirm that this has actually happened by using the TXID and entering it into an explorer to check for themselves. By doing so, they can see that the transaction was unquestionably sent and ensure that the address to which it was sent is in fact an address that is verified to be of no potential usage or belong to anyone. Therein lies the proof of burn. Anyone can check, prove and guarantee that the cryptocurrency was in fact burned and destroyed.