What Does ‘Burning Crypto’ Mean?

Burning crypto is a common practice, exercised by cryptocurrency platforms, that permanently removes tokens from circulation. By reducing the total supply of a coin, the hope is that the value of a specified digital asset will increase with market demand.

“The economic rationale for crypto burning is to control the supply of digital assets,” said Russell Stanley Geronimo, a corporate lawyer specializing in blockchain, decentralized finance and tokenomics.

The strategic maneuver creates scarcity, he explained, thereby boosting the perceived value of a coin. This increases demand simply because there would be fewer available units attached to a specified good or service.

A coin burn is a deliberate, deflationary event. It operates in likeness to a stock buyback, where companies repurchase their own shares, effectively canceling them out.

“This potentially increases the price of that asset,” said Geronimo, who currently serves as the chief legal officer at Oz Finance, a Philippines-based DeFi project where token holders can attain residency status in special zones by staking crypto. “It is similar to the way central banks retire physical banknotes or coins.”

For example, when a government prints and issues more fiat currency — government-issued currency that’s not pegged to a commodity like gold — this undercuts its purchasing power, contributing to inflation. Burning has the opposite effect.

Crypto burning may be implemented into a project as an automatic, built-in mechanism, routine maintenance run on a periodic schedule or as a one-off event.

The decision to burn crypto may be written into a project’s whitepaper prior to launch, outlining full intent to nix fractions of its supply along the way. It may also be put to a community vote, letting the decentralized autonomous organization, or DAO, decide whether to burn or not to burn.

A lucrative result, however, isn’t exactly guaranteed. The value of a digital asset fluctuates and is highly subjective, Geronimo said — especially within a volatile crypto market.

More on Crypto and Market Value This Is the Secret to Driving Growth With Cryptocurrency

 

How Does Burning Crypto Work?

Blockchain is the backbone of financial technology like cryptocurrency, which tracks and permanently records every transaction for public review. So, when a project announces that it will be eliminating a portion of its token supply, where does it go?

“[Burning crypto] is done by sending the tokens to a [crypto wallet] address where those tokens will be forever unretrievable, and can be considered as having disappeared from circulation,” said Alex Cerba, core contributor at Marinade Finance, a liquid staking protocol built on the Solana blockchain. “The address — or public key — being used for that purpose can only receive tokens but will never be able to access them.”

Functionally speaking, this allows projects and individuals to have verifiable proof recorded on the blockchain that the tokens sent to the address have disappeared from circulation.

“But burning is primarily used to reduce the supply of a given cryptocurrency … in order to give more value to the tokens in circulation.”

Public keys act as virtual vaults. Typically, they come paired with a private key, providing means to open the vault. In the case of burning crypto, however, coins are sent to a “burner” or “eater” address with no known private key. A coin burn quite literally locks away digital assets and throws away the private key.

Oftentimes, crypto is burned by owners or developers of crypto projects. Project owners may purchase a sum of the project’s available currency on the market themselves and send it directly to burner addresses. Another method for burning crypto, used by some networks like XRP Ledger, involves placing a fee on every crypto transaction and burning the collected fees.

“Some blockchains even have a built-in mechanism integrated into the protocol that burns the tokens when necessary,” Cerba said.

Taking Marinade Finance as an example, Cerba explained how its users acquire a liquid staking token, which allows a holder to unlock their assets for crypto-related activities without suffering any delays or penalties. They receive one for every Solana token, known as SOL, staked, or locked up, through Marinade’s platform. On Solana’s blockchain, these liquid staked tokens managed via Marinade show up as mSOL. So when a user is ready to reclaim their Solana tokens, the mSOL must be burned in order to maintain an accurate circulation number of mSOL to SOL in the protocol.

“Burning crypto is a necessary feature for some protocols as it represents an integral part of how they are designed,” Cerba said. “But burning is primarily used to reduce the supply of a given cryptocurrency … in order to give more value to the tokens in circulation.”

 

Reasons for Burning Crypto

The main motivation for a crypto burn is to amplify market value. In practice, the deflationary tactic has produced other favorable outcomes.

Burning crypto may be implemented as a consensus mechanism, referring to the encoded systems that keeps a network in agreement. Bitcoin, for example, uses a proof-of-work protocol that incentivizes miners, or validators, to verify transactions with a sum of tokens known as block rewards. By solving complex, computational math equations, they receive an allotted amount of Bitcoin, which halves every four years.

Stablecoins, a cryptocurrency that pegs its value to an external “stable” asset, like the U.S. dollar or gold, routinely undergo supply balancing burns — as well as new token issuances — in order to maintain their value and control inflation.

Or a coin burn may occur simply to comply with its code. Then, there’s market stratagem.

“Burning crypto can also be used to reward users for their participation in the network,” said Dmitry Machikhin, founder and CEO at crypto tracking tool platform, BitOK.

“This increases — or at least maintains — liquidity to the market, and may lead to greater investor confidence.”

By burning a set amount of coins, one can incentivize miners, or transaction validators, and other stakeholders to continue holding coins. This demonstrates a long-term commitment to scarcity, making token holders marginally richer than they would have been otherwise.

“This increases — or at least maintains — liquidity to the market, and may lead to greater investor confidence,” Machikhin said.

Burning crypto has also developed as a low-energy way for blockchain projects to increase their security and stability. When a project removes superfluous tokens from circulation, it reduces the risk of malicious actors having too much control over the market, Machikhin said. Payment protocol Ripple has an automated burn mechanism that forgoes transaction fees and protects against distributed denial-of-service attacks, or DDoS attacks, designed to overwhelm a network into inoperability.

Going further, some platforms require miners to brand the tokens they validate, marking their public address to each batch of tokens they validate — a method known as proof of burn.

More on Crypto and Tokenomics Cryptocurrency for Change: How Token Economies Are Upending Markets

 

What Is Proof of Burn?

Proof of burn is a consensus mechanism that requires miners to burn a set amount of coins in their personal possession to gain access to mine a block. By fronting a specified amount, a miner is then compensated with a block reward for verifying the transaction. This unlocks new tokens and adds a block to the blockchain.

When crypto burning is embedded as part of an algorithm’s verification system, transactions are automatically verified. These protocols save resources while maintaining a fluid, active network. 

“This acts as an incentive to keep the network secure, as miners are rewarded with new coins for destroying their old ones.” Machikhin said.

Protocols that use proof of burn include Ripple, BitShares, Slimcoin, Counterparty and Factom.

Here are the pros and cons of a proof-of-burn protocol.