What is Coin Burning?
New crypto coins start with billions of tokens. Due to the high supply, these tokens sell for a shade of a fiat currency price. How do you raise the price of cryptos to make them more attractive? This is where coin burning steps in. Taking crypto tokens out of circulation to reduce their numbers is known as coin burning. There are a lot of reasons why coins burn. Let us first take a look at how crypto coins burn.
How do Crypto Coins Burn?
An address is linked to every cryptocurrency account. This address allows the system to recognize you and is used to send and receive crypto coins.
A Crypto coin cannot be deleted or destroyed after its creation. This is why accounts are important to crypto coin burning. Blockchains have addresses that can only receive crypto tokens but not send them. A crypto coin is forever out of circulation once sent to such an address, as it cannot be sent back into the market. Coin burning, in simple terms, is when you send crypto coins to an address in a blockchain that can only receive coins.
These accounts are also known as “burner” or “eater” accounts. They do not have a private key and are not assigned to anyone. Burner accounts cannot be accessed by anyone. This is a crucial security measure to make sure burned coins are inaccessible at all times.
Why Are Coins Burned?
You may be familiar with the concept of coin burning if you have invested in stocks. It is similar to when publicly traded companies execute stock buybacks. The number of shares in circulation reduces when a company buys back stocks. It increases the share value in the market. It also helps the companies by allowing them to gain a majority over other investors and thus giving them more control.
Coin burning is similar to stock buybacks. The value of crypto tokens increases when the supply of tokens reduces. This is also used to maintain inflation or to gain control of the blockchain.
Individuals do not usually burn crypto coins as it reduces their assets. Instead, burning coins is done by managers and developers of crypto platforms. Rather than simply increasing their wealth, developers have a responsibility to maintain the crypto ecosystem, unlike individuals.
Proof of Burn
The consensus mechanism is another application of coin burning. Validation of transactions on a blockchain is implemented through consensus mechanisms.
The principle of burning coins to mine more is how proof-of-burn works. Cryptocurrency miners burn coins that they own under this system. This gives miners the right to mine new transaction blocks in proportion to the coins burned. The reward for miners to do so is in native crypto tokens of the blockchain.
A blockchain may require you to burn an alternative token from another blockchain or the native token, depending on the system used. Rewards are always received in the native token of the blockchain, regardless of the type of tokens burned.
Compared to the Proof of Work system, Proof-of-Burn is considered an energy-efficient alternative. Heavy computation is required for Proof-of-Work, whereas burning coins does not use many resources.
The Advantages of Burning Coins
Tokens are removed from circulation to create scarcity when burning coins. But does it help in increasing the price of a crypto coin? This shortage of coins can help to raise the value of cryptos. In the past, the value of Binance coin, SHIB, and Stellar have risen after they initiated coin burns.
Next, economic stability in the blockchain ecosystem is created after burning coins. There are no traditional steps to control inflation as crypto coins do not have a central authority to control their distribution. This is where burning coins are used as a deflationary tool to stabilize the token.
Lastly, a new consensus system can be created by burning coins. This is known as proof-of-burn as mentioned above. Participants in the blockchain who do not have the computing power required for proof-of-work mining can engage in the blockchain through proof-of-burn and mint crypto coins.
The Disadvantages of Burning Coins
The intention of coin burning is usually to increase the value of the crypto coin, but this is not always the case. Investor sentiment and confidence are vital to coin burning. Burning coins can have the opposite effect and backfire in some cases.
Second, investors can be tricked by developers when they burn coins. Burner addresses do not have a private key and so can not be controlled by anyone. But developers can claim to burn coins while sending them to an address they can control if they want to deceive an investor. It increases the assets of the developer and does not reduce the coins circulated on the blockchain.
Developers can also use it to conceal the size of their holdings. They can burn the majority of the crypto coins from the initial pool and take only a small percentage of tokens. This makes it look like the developer has only a few coins while holding the majority of the coins in circulation.
Coin burning is a vital deflationary tool for a token. It can increase the value of an individual’s holdings and thus create tremendous investment opportunities. New methods of consensus on the blockchain are also created by burning coins.
But it can also be misused and fail to bring the desired outcome. Understanding the concept of coin burning can help you examine crypto projects better. It can help you decide if certain crypto projects are the right investment for you.