Burning tokens I cryptocurrencies

Gepubliceerd op 6 augustus 2023 om 09:30

Token burns take place on the blockchain and cause tokens to go out of circulation (and can no longer be traded). Any blockchain could perform such a token burn, driven by the developers of a project or the community/DAO behind it.

First, what is a token burn?

A token burn involves removing tokens of a specific crypto from circulation. Each cryptocurrency has a certain number of cryptocurrencies in circulation. Increasing the number of circulating tokens is very easy, because the developer can create new tokens and through code, the number of crypto can be increased. Taking tokens out of circulation, however, is a lot more difficult. That is not a matter of changing a few digits. To remove crypto from circulation, these crypto must be burned.

A token burn is done by sending tokens to a nonexistent or wrong address. This is an address that belongs to no one. Therefore, no one can access the tokens associated with this address. This ensures that the tokens that are burned can never return to circulation.

Of course, this does not mean that the number of circulating tokens cannot grow after a token burn. For that, developers or the community can create new tokens fairly easily by changing the underlying code.

How does a token burn work?
A token burn involves removing tokens from circulation by sending them to an incorrect or nonexistent (wallet) address.

Every cryptocurrency is associated with a particular wallet address. This can be a wallet address of a user, but also an address of (for example) a smart contract. Each token is associated with a wallet address.

In a token burn, the tokens are associated with a wallet address that is wrong or does not exist. Since no one can own this wallet address, no one can ever access the tokens associated with this address either. Thus, it is impossible for someone to obtain a wallet address at a later date that is the same as the address to which destroyed tokens are linked.

By the way, this means that the tokens do not actually "disappear.'' They still exist, but can never be traded or used again.

Burning tokens yourself?
Anyone can burn tokens by sending them to a non-existent address. Do not try this as it is impossible to get the tokens back. After all, the blockchain has no customer service to help you with this. Therefore, it is also important to always check the wallet address carefully when sending tokens to another user. Check, double check the wallet address of the receiving party!

Why burn tokens?

  • Increase value
    Removing tokens from circulation reduces supply. This is likely to increase the price of the token. There are also cases of cryptocurrencies that decreased in value after the team decided to burn a large portion of the tokens. Indeed, a development team must have a good reason for a token burn, otherwise it may cause people to lose confidence in the project. 
  • Proof-of-Burn is a consensus mechanism, like Proof-of-Work and Proof-of-Stake, but less well known. This mechanism is used to achieve consensus within the network so that nodes can process transactions and validate blocks on the blockchain. The difference is that these nodes do so by burning tokens, using the token burn principle.

    In Proof-of-Work, a node must provide computing power to process transactions, while in Proof-of-Stake a node must commit tokens to a staking wallet. In Proof-of-Burn, a node must send tokens to a nonexistent wallet address to demonstrate its commitment to the network. Then, the node is allowed to validate transactions to earn money (block reward) within the blockchain network.

Pros of a token burn

  • Keep value the same or increase it - A project wants as many people as possible to buy and use their token, but for that to happen, the value will have to stay the same or increase. By a token burn, you lower the supply, while the price will increase as a result (in a general sense).
  • Better operation - a development team can effectively ensure that the network and blockchain works better, without having to make any major change to the blockchain's code immediately.

Cons of a token burn

  • The main disadvantage is the loss of crypto assets, which is a shame. Tokens can be worth a lot of money, so a token burn can quickly be an expensive operation. For example, consider a token burn of 2 million ETH. Assuming that ETH then had an average value of 1,500 euros, 3 billion euros was lost during that burn.  I can think of better places to spend that kind of money :)

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