Understanding Token Burns And Why They Are Becoming So Popular For Crypto Projects

The cryp­tocur­ren­cy mar­ket has boomed over the past decade, with many tokens boast­ing bil­lion-dol­lar valuations.

With such expo­nen­tial growth in the mar­ket, many would expect many of the thou­sands of tokens to fail or con­tin­u­al­ly drop in val­ue, but that rarely hap­pens, espe­cial­ly amongst the top 100 tokens. The val­ue of some of these tokens is con­trolled with the help of burn­ing tokens.

Since the begin­ning  of cryp­to, many projects have adopt­ed this mech­a­nism to induce arti­fi­cial scarci­ty of the tokens, con­se­quent­ly hik­ing the price. But this not-so-new con­cept is increas­ing­ly becom­ing pop­u­lar as many cryp­to com­mu­ni­ties and users cham­pi­on it.

Nonethe­less, the process of token burns dif­fers from project to project, and it is impor­tant to ful­ly under­stand how a project’s token burn will affect you and what it means. In this piece below, we dig deep­er into what a cryp­tocur­ren­cy burn is, how it works, the his­to­ry of token burns, and some prac­ti­cal exam­ples of how pre­vi­ous token burns have been executed.

What is a Token Burn?

Token burns, or sim­ply ‘burn­ing,’ is a mech­a­nism that cryp­to projects employ to per­ma­nent­ly eliminate/destroy (burn) a num­ber of tokens from the exist­ing cir­cu­lat­ing token sup­ply. This is typ­i­cal­ly done by send­ing the num­ber of tokens to a burn address, which is a dig­i­tal wal­let that can­not be accessed by any­body as it has no pri­vate key. This reduces the num­ber of tokens in cir­cu­la­tion, lock­ing them up for eter­ni­ty and pre­vent­ing any­one from access­ing them, hence cre­at­ing a ‘defla­tion­ary’ event.

The main rea­son for burn­ing tokens is to boost the val­ue of the remain­ing tokens. This fol­lows the eco­nom­ic prin­ci­ple of supply/demand, where­by if there’s less sup­ply of tokens in cir­cu­la­tion when demand remains the same (or increas­es), it will cause scarci­ty of the asset; hence the asset com­mands a high­er price.

Inverse­ly, by increas­ing the num­ber of tokens in cir­cu­la­tion while demand remains the same, the asset’s price could wit­ness a drop in value.

Burn­ing tokens cre­ate scarci­ty, and in turn, the val­ue of the asset could move upwards, and peo­ple trade it. Addi­tion­al­ly, token burns also wel­come new investors as they are viewed as a bull­ish indi­ca­tor, again boost­ing demand.

Over the years, sev­er­al projects, includ­ing Ethereum, Binance Coin (BNB), Shi­ba Inu, SWEAT Econ­o­my,  and hun­dreds of oth­ers, have employed this method to increase their val­ue. While burn­ing may be viewed as bull­ish, it always does not reflect on the price imme­di­ate­ly, as some token burns are auto­mat­ed to hap­pen reg­u­lar­ly or are dis­closed well in advance. This means the price will be effec­tive­ly priced well before the token burn takes place.

The Importance of Token Burns

As allud­ed to, token burns are an effec­tive way for cryp­to projects to reduce the total sup­ply of cir­cu­lat­ing tokens. Reduc­ing the sup­ply makes them more scarce and poten­tial­ly valu­able, which could cre­ate a pos­i­tive feed­back loop where­by prices spike, and more investors jump on the band­wag­on, fur­ther increas­ing the demand.

Sec­ond­ly, planned burn sched­ules, such as BNB quar­ter­ly burn, pro­vide a more bal­anced ecosys­tem, in this case, for the BNB ecosys­tem. By burn­ing cryp­to, the project reduces the advan­tages that ear­ly min­ers or investors have over new users of the token. As coins reduce, the blockchain net­work ben­e­fits investors equal­ly, pro­vid­ing more val­ue to every investor in the project.

Third­ly, burn­ing tokens also increas­es the trust in devel­op­ers and shows they are com­mit­ted to the project. How? Reduc­ing tokens shows that the devel­op­ers are will­ing to reduce their token kit­ty and sac­ri­fice their own sup­ply (or the float­ing sup­ply) for the greater ben­e­fit of investors, as explained above.

Final­ly, some projects apply a set sched­ule of burn­ing the tokens, proof-of-burn (PoB), one of the con­sen­sus algo­rithms that ensure all par­tic­i­pat­ing nodes in the net­work val­i­date the state of the blockchain.  PoB oper­ates on the prin­ci­ple of min­ers and, at times, investors vot­ing on burn­ing these tokens. Once burnt, min­ers are grant­ed the oppor­tu­ni­ty to mint the same pro­por­tion of tokens burnt.

One key exam­ple is the recent gov­er­nance vote by SWEAT Econ­o­my that allowed investors and token hold­ers to vote on either burn­ing 100 mil­lion $SWEAT tokens or dis­trib­ut­ing them to exist­ing token holders.

Real-World Examples of Token burns

As explained above, token burn­ing is almost like cryp­to itself. In fact, some of the ear­li­est and most suc­cess­ful projects have used token burn­ing as part of their strat­e­gy. Below, we dis­cuss some of the real-world exam­ples of some of the most famous token burns in cryp­to history:

‘Mistake’ Burning

While it goes most­ly unno­ticed, mis­take burns are one of the most pop­u­lar ways tokens are burnt. For instance, Bit­coin is arguably the first and most famous exam­ple of these “mis­take” burns. When­ev­er a user los­es their pri­vate keys or sends the tokens to an inac­ces­si­ble (invalid) wal­let address, those BTC are effec­tive­ly burned, as they will nev­er be accessed for­ev­er. Accord­ing to some esti­mates, over 4 mil­lion BTC have been effec­tive­ly burned, account­ing for 20% of the total supply.

Buyback and burn (Binance Coin)

Binance coin (BNB) burn sched­ule involves a buy­back and burn mech­a­nism where­by the project uses part of its rev­enue or prof­its to buy back tokens from the mar­ket and burn them. This increas­es the demand and reduces the sup­ply, cre­at­ing upward pres­sure on the price.

When BNB was launched in 2017, a com­mit­ment was made to remove 100 mil­lion BNB (half of its total sup­ply) from cir­cu­la­tion through a burn­ing process. The lat­est burn (23rd burn) saw 2,020,132.25 BNB (~$676,744,304).

Fee burn (Ethereum)

As Ethereum tran­si­tioned to its proof of stake (PoS) con­sen­sus algo­rithm from proof of work (PoW), the com­mu­ni­ty decid­ed to burn part of the fees col­lect­ed. The EIP-1559 update, intro­duced in August 2021, burns ether from the fees gath­ered from val­i­dat­ing and ver­i­fy­ing the network.

Accord­ing to Bea­con­cha, 3252529.9 ETH (~$5,931,837,296.25) have been burned since August 2021, as of writ­ing, reduc­ing the num­ber of ETH tokens in cir­cu­la­tion. The des­ig­nat­ed burn address is 0x0000000000000000000000000000000000000000 and does not have a pri­vate key, which means any tokens sent there are effec­tive­ly destroyed.

Governance burn (Sweat tokens)

Gov­er­nance in cryp­to has been a thing since the launch of decen­tral­ized autonomous orga­ni­za­tions (DAOs) back in 2015, giv­ing token hold­ers pow­er over deci­sions on the progress of the plat­form. While some token burns are planned, plat­forms such as Mak­er­DAO lets the com­mu­ni­ty select whether to burn or not.

Of the avail­able token burn­ing mech­a­nisms, gov­er­nance vote token burns cre­ate the most trust­ed and inter­est­ing kind of token burns. Sim­ply, the com­mu­ni­ty votes on whether to burn tokens and how many tokens to burnt in a demo­c­ra­t­ic way.

One of the inter­est­ing token burns through decen­tral­ized gov­er­nance votes in recent times is the SWEAT token’s April gov­er­nance vote. Unlike oth­er burn­ing sched­ules that vote on token burns exclu­sive­ly, SWEAT intro­duced a token vs dis­tri­b­u­tion gov­er­nance vote, allow­ing the com­mu­ni­ty to vote on whether to burn 100 mil­lion SWEAT tokens or dis­trib­ute them to users with a 12-month growth jar by 25 April.

As expect­ed, the com­mu­ni­ty was divid­ed when it came to choos­ing one of these two options. With 153,783 users par­tic­i­pat­ing in the vote, 91,481 users (59.487%) vot­ed to dis­trib­ute, while 62,302 users (40.513%) vot­ed to burn tokens. In a first-of-its-kind vote, the 100 mil­lion SWEAT tokens were divid­ed as the vot­ers decid­ed, with 59,541,465.013 SWEAT dis­trib­uted and  40,549,975.987 $SWEAT burned.

“It was cool to have the vote in-app and be trans­par­ent with the results. I’d like one on a con­tract next time to be sure,” anoth­er SWEAT vot­er shared.

NFTb, an NFT pro­to­col built on the BNB chain car­ried out its first DAO-sanc­tioned token burn in Jan­u­ary,  allow­ing the com­mu­ni­ty to choose how much of the NFTb the pro­to­col will burn. The com­mu­ni­ty had to select what por­tion of the total sup­ply of tokens was to be burned, with choic­es includ­ing 5%, 15%, and 25%. The com­mu­ni­ty select­ed o burn 25% of the tokens, which result­ed in a 4X increase in price.

Algorithmic stablecoin token burns (Terra stablecoin, UST)

Final­ly, algo­rith­mic sta­ble­coins also con­duct auto­mat­ic token burns to con­trol the sup­ply of their tokens. For instance, if the demand for an algo token ris­es and the price los­es its peg and goes above $1, the plat­form will auto­mat­i­cal­ly mint new tokens and flood them in the mar­ket until the price retracts to $1. Con­verse­ly, if the demand for a token falls and the price drops below $1, the plat­form will auto­mat­i­cal­ly buy back tokens and burn them until the price ris­es back to $1.

One of the most famous algo sta­ble­coin burns is Terra’s UST token which blew up in ear­ly 2022. To main­tain the price sta­bil­i­ty of UST, the Ter­ra Net­work used its native cryp­tocur­ren­cy, LUNA. If the price of UST went above $1, users could burn LUNA tokens to mint UST, increas­ing the sup­ply and effec­tive­ly bring­ing UST back to $1, and vice ver­sa. How­ev­er, once the price of LUNA col­lapsed in mid-2022, bring­ing UST down with it – los­ing investors over $60 billion.

Meme coins burn (SHIBA INU)

The grow­ing inter­est in meme coins such as Doge­coin, Shi­ba Inu, and Pepe in recent times has fol­lowed, with some of the projects select­ing to burn their tokens to reduce their hyper-inflat­ed sup­ply. Late last month, Shi­ba Inu (the sec­ond-largest meme coin) announced it had com­plet­ed its largest-ever dai­ly token burn, with a record 41 Mil­lion SHIB tokens sent to the burn address in a day, on May 24th.

Shi­ba Inu has had an inter­est­ing burn rate sched­ule since the first burn when Vita­lik Buterin, the founder of Ethereum, burned over 90% of SHIB tokens received from the cre­ators of Shi­ba Inu. In May 2021, Vita­lik decid­ed to burn approx­i­mate­ly 410 tril­lion SHIB tokens (or 40% of the total SHIB sup­ply), mark­ing one of the token’s great­est moments. Shi­ba Inu prices increased by near­ly 40% after Vita­lik burned the SHIB tokens.

Conclusion

Token burn­ing is a pow­er­ful mech­a­nism that can cre­ate val­ue and util­i­ty for cryp­to tokens.

By reduc­ing the sup­ply and increas­ing the demand for the tokens, token burn­ing can boost their price and scarci­ty. Nonethe­less, there are poten­tial risks to token burn­ing, such as whales tak­ing advan­tage of the token burn where­by they sell their tokens as soon the token price shoots up a bit, affect­ing the token’s val­ue increase.

Addi­tion­al­ly, some untrust­wor­thy plat­forms may rug-pull their com­mu­ni­ty, promis­ing to burn tokens, but in real­i­ty, they send the tokens to an acces­si­ble wallet.