When a cryptocurrency community decides they want or need to destroy units of a specific cryptocurrency, they use a process called coin burning. burning cryptocurrencies is the process that effectively takes those tokens out of circulation, reducing the total supply of that currency and, in some cases, increasing demand.
The burning of cryptocurrencies is similar to the buyback of shares. This is when the company that issued the shares buys back a number of shares and reduces the total number of shares in the market.
Reading: Why power burning bitcoin
While burning a coin can increase the value of a given cryptocurrency, there is no guarantee that this process will increase the price or (if it does) that the price will not decrease. in fact, there are several other reasons developers might choose to burn coins.
what is cryptocurrency burning?
So what exactly does it mean to burn crypto, given that all “currencies” are digital and exist through blockchain technology?
First, think about how cryptocurrencies are bought and sold. merchants can exchange crypto by sending it to and from a crypto wallet, using their private keys. To run a coin burn, users send their crypto to a “dining address” or a burn wallet, which is a crypto wallet that only receives tokens, but cannot send them. therefore, those coins are effectively blocked and taken out of circulation.
That transaction, confirmed in the blockchain ledger, causes the coin to be burned permanently and irrevocably.
6 reasons to burn cryptocurrencies
There are a few reasons why different cryptocurrencies might want to burn coins. some projects include this process from the beginning, as part of the protocol itself, while others choose to assume it in some form later on.
With the rise of decentralized finance (defi) protocols, coin burning has become more common. here are some cases where it makes sense to burn coins.
1. as a consensus mechanism
some coins use proof of burn (pob) as a consensus mechanism on the network. this requires both miners and users to burn some of their coins on a regular basis. Proponents of this method consider it an efficient way to verify transactions because it doesn’t use any real-world resources.
There are several specific methods to use this consensus mechanism, such as:
• In a pob network, miners have to burn some of their coins to mine new blocks. It sounds counterintuitive, but miners then get rewarded in the form of new coins when they verify a new block of transactions.
• some coins require the burning of a different cryptocurrency in exchange for new tokens on the new network. miners might have to burn bitcoin, for example, to earn another coin.
• some blockchains use more complex forms of pob, like burning native tokens for credits. holders can use those credits to perform a function on the blockchain. sometimes this involves constantly minting new coins and burning a portion of the coins.
2. to protect against spam
Coin burning can help protect a network from Distributed Denial of Service (DDOS) attacks and prevent spam transactions from slowing down the network. here’s how: just like bitcoin users pay a small fee to send transactions, or ethereum users pay a gas fee for smart contract calculations, some networks require miners/validators to burn the fees they get for the transactions.
This mechanism can automatically burn a part of each transaction that is sent. ripple (xrp), for example, uses this method.
3. to increase the value of a coin
The basic economic law of supply and demand dictates that if the supply of something goes down, then the price will have to go up, assuming demand remains constant. this is part of the reason why satoshi nakamoto (the pseudonym used by the person or people who created bitcoin) programmed the bitcoin protocol to “halve” it every four years, reducing the block reward for miners by 50%. therefore, fewer bitcoins enter circulation.
Coin destruction can serve a similar purpose. burning coins reduces supply.
While fiat currencies are inflationary in nature and central banks can print them in unlimited quantities, some cryptocurrencies are deflationary in nature and have fixed supply limits. bitcoin has a supply limit of 21 million coins.
The more people want to buy, hold or use bitcoins, the faster the price will tend to rise because there aren’t as many coins to go around. As long as demand remains constant and supply remains limited, the price of bitcoin can continue to rise compared to any fiat currency. past performance, of course, is no guarantee of future results.
For other cryptocurrencies, engaging in coin burning can sometimes be an effort to manage supply in a way that increases scarcity and attempts to mimic bitcoin’s supply and demand dynamics.
4. to keep stablecoins stable
Coin burning may be necessary in the case of stablecoins, because burning a certain part of the supply can help the stablecoin remain pegged to its fiat currency (such as the dollar).
for example, if the demand for a stablecoin increases and the price exceeds its dollar parity, the protocol’s smart contract will automatically issue new tokens to reduce the price, or burn coins to increase the price so that its parity in dollars remain constant.
5. as a sign of long-term commitment
Owners of a crypto project sometimes burn coins on their network as a show of commitment to scarcity. maintaining a certain degree of scarcity (see bitcoin, with its limit of 21 million) makes everyone who has those coins a little bit richer. Owners can accomplish this through a burnout mechanism, by providing periodic burnout programs or as a one-time event.
Some investors see this strategy as a way to keep the value of a currency rising, and therefore can help investors feel more confident about staying invested for the long term.
6. to promote mining balance
In some cases, the pob system may set the crypto burn on a regular cadence which helps maintain a balance between new users and early arrivals, e.g. the first and sometimes the biggest investors on that platform.
That’s because the pob consensus mechanism, which requires burning coins to validate transactions, helps stimulate the mining of new coins. so this allows for a balance between new users and the old guard.
pros and cons of burning cryptocurrencies
Obviously, cryptocurrency burning has some advantages for the platform and certain users, but as more projects embark on coin burning, the disadvantages are also worth considering.
advantages of burning crypto
• Coin burning can enhance the value of a cryptocurrency by limiting the supply. An increase in the price of a burned coin is not guaranteed, but it has happened, although a drop may also follow.
• coin burning can help control the inflation of a particular cryptocurrency, eg. stablecoins.
• Using proof-of-burn as a consensus mechanism is a low-power way to validate transactions and create new coins, keeping the supply in balance.
• Related to the above, test recording can help protect the network from attacks.
cons of burning cryptocurrencies
• Burning a coin may have little or no impact on the price in the long run.
• Sometimes coin burning can be faked and developers use the “burn” function to send coins to your own address.
• Instead of decreasing supply and increasing demand, burning coins can sometimes turn off investors if they feel manipulated or lose confidence in the project.
different types of coin burning
Coin burning typically falls into one of three categories:
1. burning coins at the protocol level
The proof-of-burn consensus algorithm discussed above falls into the first category. Blockchains using pob have coin burning built into their protocols. this means that burning is an intrinsic part of the network and is carried out constantly as long as the coin is running.
The use of coin burning as a spam protection mechanism can also occur at the protocol level. As mentioned above, transactions must come at a cost to prevent the network from being spammed with fake transactions. One way to accomplish this is to automatically burn a portion of each transaction fee.
2. burning coins as economic policy
The second category involves developers who might decide to burn coins to control the coin supply in order to manage inflation.
an example could be the deliberate destruction of unsold ico tokens. The creators of a new project could have created x number of coins in the hope of selling them all, but they were unable to meet this goal. in such a scenario, developers could choose to burn excess coins to maintain a specific level of supply.
3. burning coins instead of dividends
Some projects may also use coin burning as a kind of dividend payment to coin holders. If the owners of a token have a business that generates cash flows, like a cryptocurrency exchange, for example, the token holders could receive rewards through coin burning.
In a boon to those who chose a hodl strategy, owners could buy back tokens from holders and burn those coins, thereby increasing the value of everyone’s cryptocurrency. this could occur instead of traditional dividends that could trigger securities regulations. the recording process could occur as a one-time event or as a regularly scheduled one.
history of crypto burns
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As noted above, the process of burning coins to limit supply and increase demand likely stems from Wall Street’s long tradition of share buybacks to improve share prices and reward shareholders. however, in the case of cryptocurrency burns, the reasons can be more complex.
different reasons to burn crypto
There is currently nothing unusual about burning a coin. and there have been several well-known coin burns, usually starting in 2017. some of them were at the protocol level (i.e. the burn(s) were built into the project itself), and some burns were run to limit supply and raise cash, or in lieu of dividends (as noted above).
• In 2017, for example, Binance Coin (BnB) began its series of quarterly burns. bnb launched with a total supply of 200,000,000 and will continue its burn program until 100,000,000 coins are burned, or 50% of all bnb in circulation. The 20th bnb burning occurred on July 13, 2022.
• By contrast, bitcoin cash (bch) suffered a coin burn in 2018 that pushed the price up temporarily. and stellar (xlm) did a one-time burn of 50% of its supply in November 2019. This was with the express intention of limiting the number of coins and increasing demand.
• More recently, ethereum made headlines when the platform burned over 2 million of its ether tokens in March 2022: the burn was worth nearly $5.8 billion. however, this burn was automated as part of an earlier fork of the ethereum blockchain that laid the groundwork for this coin burn: eip-1559.
the increase in burning coins
While some view burns with a skeptical eye, there’s no arguing that this strategy has become more popular, particularly for new cryptocurrencies launching in large numbers.
One tactic investors will notice is that a new crypto could launch with over a billion or even a trillion coins, typically worth a fraction of a penny, with the intention of burning off some of that excess supply later to increase prices.
shiba inu coin burning
The case of the shiba inu burning strategy, or burning controversy, is a good example of how some platforms try to manage a large circulating supply, a very low price and investors eager to make a profit.
shiba inu (shib) is worth $0.000019 as of August 3, 2022, with a total supply of around 549 billion shib. the coin burn done in late July 2022 only burned about $13,500 worth of shib, or 0.0002% of its supply.
While shib has a loyal group of investors, some question the merits of burning shib coins.
invest in crypto today
burning coins involves taking them out of circulation and destroying them forever, permanently reducing the available supply of that token. The exact reasons for doing this can vary, from platforms that essentially program coin burning into their protocol, to cryptocurrency developers who simply want to see a price increase.
Although the crypto community generally views coin burns as more positive than negative, there is still a lot of skepticism about coin burns. Different types of cryptocurrencies use coin burn in different ways, and it’s important to understand the approach of any cryptocurrency you’re considering investing in.
The sofi invest® platform makes it easy to buy and sell cryptocurrencies when you set up an active investment account through the sofi invest app. sofi does not offer crypto wallets or staking, but you can trade dozens of different cryptocurrencies, 24/7, from the safety and comfort of your phone or laptop.
frequently asked questions
what are crypto burns?
Crypto burns, also known as coin burns, are when a project decides to take a certain number of coins out of circulation.
why do crypto burns happen?
there are several reasons. two common ones: burning coins is part of the general protocol of the platform and is predetermined. in another case, developers burn coins to limit supply and potentially increase demand. it’s a good idea to research why a coin is burning to understand the impact on crypto in general.
can burning cryptocurrencies increase its value?
burning cryptocurrencies may increase their value, but is not guaranteed to do so. One thing that becomes clear when looking at the performance of different coins after a burn: even if the price goes up, there is no guarantee that it will stay there.
photo credit: istock/aliaksandr bahdanovich
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