Crypto burns have been in the spotlight over the past few weeks, mostly due to the ongoing Shiba Inu (SHIB) token burns. The developers of this meme coin are on a burning spree to save their coins from devaluation in a very volatile crypto market. To date, nearly 260 billion SHIB tokens worth $ 25,000 have been burned, and new burning mechanisms have also been put in place to capture this strategy.
But why burn coins?
When some crypto tokens are said to be burned, it means they have been permanently withdrawn from circulation. This is done by simply transferring the token to a ‘dead wallet’. The private key to this wallet is unknown, so the crypto is lost forever.
But why would a developer burn cryptocurrency?
When there is an excess of cryptocurrencies in the market, the price of these tokens remains low because demand never exceeds supply. In such a scenario, burning a portion of the cryptocurrency acts as a ‘deflationary’ move. The scarcity of tokens increased and triggered an appreciation of the price of tokens that were still in circulation.
One of the most famous crypto burns was when Ryoshi, the creator of Aliased from Shiba Inu, gave Ethereum founder Vitalik Buterin 50% of SHIB’s supply when it launched. However, in 2021, Buterin burns 90% of the tokens and donates the rest to charity, stating that he does not want to be a “locus of power”. The tokens burned are estimated to be worth $ 6 billion and will now turn into trillions of dollars.
But what happens under a burn transaction? How are these coins burned? Well, coin burning can be divided into two main categories, namely:
1. Protocol Level Mechanism:
Proof of Burning (PoB): This consensus mechanism requires users to stake coins to become network validators. However, the staked coins are sent to a dead wallet, after which, they are no longer accessible or spent. The more coins you burn, the greater your chances of becoming a validator.
After burning the coins, the user can qualify as a validator and receive a newly printed coin for each block that is verified and added to the blockchain. These mining rewards then have to be appreciated over time because of the continuous burning of coins as part of the network consensus mechanism (users continuously burning coins to qualify as validators).
Burns Per-Transaction: Cryptocurrencies like Ripple (XRP) are coded to burn a fixed number of tokens as part of each transaction. It is usually taken from the gas cost paid by the transactor and will be diverted to the burning address. While the cost of gas ensures that a legitimate transaction is passed, burning a small portion ensures the token maintains its value.
2. Economic Stability Movement:
Coins not sold at ICO: The new tokens are launched in an Initial Coin Offering (ICO), where investors bid to gain ownership of the tokens. However, some tokens may not be sold at the end of the event. The developer may decide to get rid of the token by burning it. This resulted in a significant price increase for existing owners and the developers themselves. This is also a sign of the developers ’commitment to the long -term goals of the project.
Dividend Burns: This is a mechanism to reward those who have existing tokens. Blockchain like Binance implements a buyback-and-burn strategy where they buy back some tokens from an open market (at market price) and burn them. The price appreciation of this move is a dividend reward for investors who hold the token.
Blockchain periodically burns original tokens to maintain or increase their value. This periodic combustion is achieved by using the ‘burn function’. This smart contract automatically sends a specific number of circulation tokens to the burned address. Binance aims to eliminate 50% of volume with this strategy.
One of the most significant crypto burns in history was the Terra network in November 2021. Terra burned 88.7 million LUNA tokens totaling $ 4.5 billion at the time. Terra also burned another 29 million LUNA tokens worth $ 2.57 billion in February 2022.
Crypto burning has only one purpose – it increases the value of each remaining token. Sometimes developers announce massive crypto fires, but instead of sending assets to dead wallets, they simply direct them to controlled wallets that can be used for malicious purposes. That’s why diligence is so important before investing in any cryptocurrency.