Why do we love Bitcoin? It offered us something that traditional finance doesn't have.. BTC has a fixed maximum limit of 21 million coins. No one is able to create more tokens. This helps to keep the demand and value of "digital gold" high. But what about other crypto? Do they have limits? Well, not exactly. Let’s take Ethereum, for instance. It works a little differently. ETH became a deflationary currency after the London hard fork, when developers implemented a burn mechanism. Many other altcoins and even NFTs also have this mechanism. Let's find out how it works.
Why should cryptocurrencies be burned?
Burning is a process that takes away a certain amount of coins from circulation. They can be withdrawn using special smart contracts, or sent to an address from which they can never be returned. The decision to burn tokens can be made by the project team. Also, in some cases, burning can be done by the users themselves, for example, as it was and is with LUNC, you can send your coins to the burning address by yourself. There is a similar model in Shiba Inu.
Many crypto projects have implemented this method for several reasons:
- By withdrawing coins from circulation, the price of an asset can rise;
- It reduces the load on the network;
- A good marketing step that may attract new investors.
A nice example of burning tokens are BNB coins. Every quarter, Binance buys back 20% of their entire income from the BNB coin and burns it. They will do this until 80,000,000 BNB are burned, which is 40% of the total emission.
How to burn tokens using Proof of Burn?
Proof of Burn is a consensus mechanism invented by Ian Stewart. It was first used on the Slimcoin blockchain. PoB algorithm burns coins by sending them to an address from which they can never be taken. Tokens are not actually destroyed, they are simply sent into the "black hole" and can no longer be accessed. Some blockchains use this consensus model to regulate (reduce) the supply of tokens.
Advantages of the Proof of Burn algorithm:
- It does not require as much electricity as the Proof of Stake consensus.
- No special equipment is needed.
- Burning coins reduces their number and helps increase the price.
- Not tested on a large network.
- The scalability of PoB has not been proven.
- The process of burning coins is not always transparent.
The more coins a miner sends to that address, the more likely he will be chosen to validate the next block on the network. If he correctly checks the transactions and extracts the block, he will receive a reward. If not, he will just burn the coins and spend his money.
How to burn tokens using transaction fees?
Many blockchains use smart contracts that automatically burn some of the transaction fees. The efficiency of this process depends on the amount of operations: the more operations are completed, the more coins will be burned.
The fee burning method reduces the number of coins automatically, smoothly and almost unnoticeable. Ethereum burns its fees through the EIP-1559 protocol, which was implemented through the London hard fork. The same principle is used by the Polygon blockchain and a number of other networks. Ethereum has destroyed almost $3,5 billion of its tokens. A slightly different mechanism is used by the Shiba Inu. They have a SHIB Burn service where holders can burn their meme tokens and receive rewards in burnt SHIB tokens.
How does burning affect tokens price?
The coin burning process is a tool for deflation, which helps to reduce the supply of some cryptocurrencies. Due to that the price of an asset might even increase. A good example of it is the BNB coin. After the latest burn on July 13 tokens price went up. Depending on what method, in what volumes some coins are burned, the impact on the value of an asset might be different, it can be aimed at a long-term perspective, or maybe for a short-term price change.