What is token burning?
Imagine a famous restaurant deciding to reduce the number of dining tables to create a more luxurious and exclusive feel, with a limited space. Similarly, token burning in the cryptocurrency space reduces the total supply of tokens, which can increase the value of the remaining tokens.
The token burning process occurs when a project sends the number of tokens to be burned to a special wallet address that can only receive tokens but cannot send them out. This makes these tokens permanently inaccessible — similar to locking them in a random wallet with an unknowable private key, and protecting against attack behaviors.
The address used to burn tokens is usually decided by the project or community, ensuring randomness, high security, and complete irretrievability. Since no one can recover or use these tokens, they are considered to be 'burned' permanently.
Token burning is often carried out by cryptocurrency projects to control supply and create scarcity, attracting investors and stabilizing the market. If traditional companies achieve similar effects through stock buybacks to reduce the number of shares outstanding, then token burning is a characteristic method in the cryptocurrency world, reflecting the project's commitment to long-term goals.
By permanently removing a portion of tokens from circulation, token burning can increase the value of each token, just as limited edition items become more attractive as supply decreases. This scarcity can attract investors, while also providing potential benefits for current investors through increased value, thereby emphasizing the project's long-term commitment.
Token burning is considered a strategy to increase token value by adjusting the balance of supply and demand. Although not all tokens apply this method, it is a common practice in smaller or emerging projects to stabilize the market and build investor trust.
How token burning works
The token burning process involves a series of steps to ensure tokens are permanently removed from circulation, with each step playing a crucial role in making these tokens non-tradable.
Step 1: Decide to burn tokens
First, the decision to burn tokens usually comes from project developers or regulatory bodies. Token burning can be implemented as an economic strategy to increase scarcity or respond to community feedback.
Some projects implement deflationary mechanisms, whereby tokens are periodically burned to reduce supply over time. Others design tokens with automatic burning mechanisms, such as burning a portion of transaction fees or staking rewards.
Projects adopt various methods for burning tokens. Some implement it on a fixed schedule, like Binance with its quarterly burns adjusted based on trading volume. Others use a transaction-based burning method, in which the transaction fee is permanently removed after each transaction. For example, Ripple burns a portion of the transaction fee as a mechanism to prevent spam on its network, differing from Binance's periodic burns.
Unlike other cryptocurrencies, stablecoins like Tether's USDT are pegged to fiat currency or assets, requiring equivalent reserves. When users convert USDT to fiat, tokens are 'burned' to maintain the 1:1 peg, meaning those tokens are permanently removed from circulation. Conversely, when new fiat is deposited, the corresponding amount of tokens will be issued. This mechanism ensures that the supply of stablecoins always aligns with the underlying reserves, maintaining stability and trust in the pegging rate.
Step 2: Define the amount of tokens to burn
After a decision is made, the project team determines the number of tokens to be removed from circulation. This number can be a fixed amount or a percentage of the total supply, depending on the goals of the burn.
Smart contracts on the blockchain will check whether the requester has enough tokens in their wallet to complete the burn. The system also ensures that the specified amount is valid — it must be greater than 0 and a positive number. If the requester does not have enough tokens or the amount is invalid, the burning process will not be carried out.
Step 3: Send tokens to the burn address
When tokens are burned, they are typically sent to a special wallet address, often referred to as the 'burn address' or 'null address.' Tokens in this address will be frozen and permanently inaccessible.
To initiate the burning process, the project uses a function called the 'burn function' on the blockchain. This specific command informs the network to proceed with the burning process. When this function is activated, the number of tokens to be burned will be specified.
Step 4: Verify the burning process on the blockchain
The token burning process is carried out transparently. When tokens are sent to the burn address, the transaction is recorded on the blockchain and anyone can verify it.
Many projects also announce 'burn events' to the community, keeping this process transparent. This openness helps maintain trust and allows the community to track burn events on the blockchain, ensuring that tokens have indeed been removed from circulation.
Why do projects burn tokens?
Although the primary purpose of token burning is often to increase value by reducing supply, the benefits it brings go beyond creating scarcity.
Enhancing investor confidence
Regularly burning tokens can help build trust and confidence in the project's community. Users who see a project committed to a scheduled token burn often consider this a sign of stability and long-term development goals.
Projects can alleviate investors' concerns about inflation or market dilution by demonstrating that the supply will continue to decrease, thereby reinforcing their confidence.
Fix technical issues
In some cases, token burning is used as a practical solution to fix technical errors or unintended token creation. For instance, if a technical error leads to the issuance of unwanted additional tokens, burning these excess tokens will prevent them from destabilizing the cryptocurrency.
Stabilizing algorithmic stablecoins
Token burning plays a particularly important role in algorithmic stablecoins, which are designed to maintain stable value, often pegged to a fiat currency. Stablecoin projects use token burning to eliminate excess tokens from circulation, helping to keep the value of the coin stable according to the pegged ratio.
For example, the system may issue additional tokens if the price of the algorithmic stablecoin rises above the target level. Conversely, if the price falls, tokens will be burned to reduce supply, thereby helping the value return to a stable level.
Enhancing security and reducing spam transactions
Token burning also helps protect the network. Some blockchains burn a small amount of tokens from each transaction fee. This not only helps prevent spam transactions but also protects the network from being overloaded or from distributed denial-of-service (DDoS) attacks.
By attaching costs to each transaction, projects reduce the risk of malicious actors exploiting the network for quick gains or disrupting operations.
Gaining mining rights with the proof-of-burn mechanism
Some blockchains use a unique method called proof-of-burn (PoB) as part of the consensus mechanism. In this case, miners must burn a portion of their tokens to gain the right to mine new blocks and receive rewards.
The sacrifice of these tokens represents the miners' commitment to the network, while also helping to maintain security and balance resource usage without the need for high energy consumption like the proof-of-work (PoW) mechanism.
Token burning and minting new tokens
Minting new tokens is the process of creating and adding new tokens to the blockchain. This usually occurs when:
Tokens are created for initial sale.
Tokens are used as rewards for network members, such as miners or validators.
Tokens are issued to raise funds for project development.
The process of minting new tokens helps ensure that the supply is sufficient to meet demand, especially as the network expands or requires additional tokens for various activities.
Token burning, on the other hand, is the process of removing tokens from circulation. The goal of this is to maintain a balance between minting and burning tokens to ensure that the number of tokens created is sufficient to meet demand without causing inflation in supply. At the same time, token burning helps control supply, keeping value stable for users and investors.
Aspect Token Burning Minting New Tokens Purpose Reduce supply, potential increase in value due to scarcity Increase supply to meet demand or raise funds for the project Impact on Value Can increase in value through creating scarcity Can dilute value due to increased supply Example BNB Coin (BNB) conducts quarterly token burns ICO, staking rewards Impact on Supply Reduces circulating supply Increases circulating supply Method Tokens are sent to a burn address (irreversible) Tokens are created and added to the blockchain
In many token economies, the processes of minting and burning tokens are mechanisms that are interdependent. For example, projects may mint tokens to reward users or provide liquidity, but at the same time conduct token burns to reduce inflation and maintain scarcity. Token burning can create deflationary pressure, contributing to the increase in value of tokens as supply decreases. This balance is crucial for projects that want to encourage users while ensuring economic stability.
Some blockchains also use token burning as part of transaction fees, where a portion of the fee is removed from the system to help control supply. By combining token minting and burning, projects can effectively manage the supply, demand, and value of tokens in the ecosystem.
