One of the common practices in the cryptocurrency industry is called token burning, which may be a confusing concept to some cryptocurrency enthusiasts and users. However, there are some pretty strong and important reasons to burn tokens, which we will talk about today.
So, if you want to learn more details about tokens, token burning, as well as reasons and methods of doing so, simply keep reading. In addition, we will also talk about how token holders can benefit from token burning, so if you are a cryptocurrency holder, or you plan to become one — you will learn something that might help you make a better investment decision in the future.
What is a token?
First, let’s establish what a token is. As you may know, tokens are a form of a cryptocurrency, although not quite like Bitcoin, which is a digital currency meant to be used as an actual currency. Instead, tokens are cryptocurrencies that are meant to be used within their own ecosystems.
Of course, they could still be used as currencies, outside of their ecosystems, provided that someone is actually accepting them as such. However, when it comes to their own networks, they are dominant assets that grant their holders a right to participate within the network.
In other words, they can function like digital assets, or represent the share of the company that has launched them, or even have some special use within the network. The possibilities are numerous, and they depend on how the project is organized, and what the developers had intended for their token and users to be capable of.
About token burning
Now that we know what exactly tokens are, it’s time to talk about token burning itself. To put it quite simply, token burning is a process of permanent removal of a token from circulation.
Of course, the process doesn’t involve the actual burning of anything — the tokens are simply removed from circulation and locked away, permanently. As you may know, most projects that do not have all of their tokens mined have two types of supplies. The first one is a total supply, which decides how many of the project’s tokens can ever be in existence. On the other hand, the circulating supply represents the number of tokens that are out in the market, available for use by the community.
In theory, the token burning procedure can be used by any cryptocurrency, although larger projects rarely use this method of control over their crypto’s supply. Instead, this is mostly something that smaller projects use to decrease the number of tokens. It is also a practice that is adopted by ICOs, where projects offer a specific number of tokens, and then burn those that do not get purchased and distributed during the ICO.
Reasons for burning tokens
There can be a number of reasons why a project might decide to burn tokens, but the most common one is to raise its price and prevent inflation. As you may know, the more tokens there are in circulation, the lesser their value is. This is also true for fiat money or other assets.
This is also why Bitcoin is so highly valued in the crypto community, as there can only ever be 21 million BTC in existence. On the other hand, BTC is still a few million coins short of reaching its total supply. But, even if it did reach its total supply, there would only be 21 million coins for the entire world to use, and there is likely no need to remind you that the world consists of billions of people, which is why many are convinced that BTC price will rise to accommodate the world for the lack of extra units.
Most other projects release a lot more tokens into circulation in order to provide their users with the ability to collect more of them for different reasons. As mentioned, this could be done in order to get greater voting privileges within the ecosystem, or to own a bigger share of a company, and alike.
However, if the number of issued coins ends up being too large, token burning is used to reduce the existing circulating supply and make the remaining tokens more valuable. With the tokens having their value go up, it is more likely that their users will continue to trade them and support the project, thus increasing its chances of reaching even greater adoption.
Another reason for burning the tokens concerns security tokens, or securities. These tokens provide dividends to their holders, and burning them is not unlike the buyback of company shares. After that, their burning once again increases the value of the tokens that are still being held by other holders.
How does token burning actually work?
As mentioned, the goal of token burning is to remove existing coins from circulation and reduce their number, which is pretty simple as a concept. However, there are several methods of doing this. We also stated previously that there is no actual burning involved, and the tokens do not actually get destroyed. However, they do get removed or made unusable.
The process starts with the development team that has created the token, and it involves buying back the tokens from its users. Alternatively, the tokens can also be removed by making those that were not purchased yet removed. The team does it by taking the token signatures, and putting them in a public wallet from which they cannot be removed. These wallets are often called eater addresses, as they permanently freeze the tokens placed within.
The blockchain that the tokens are used on then records the action, and everyone who tries to track down those tokens can see that they were burnt.
Of course, there are several ways of going about token burning, as mentioned. Some projects only burn tokens once, after completing the token sale. They would burn the tokens that were not sold, and increase the value of those that are in the hands of the users. Some projects organize token burns multiple times, or even on a regular basis. Sometimes, this is simply another part of the project’s way of operating, with its team regularly burning a specific number of tokens.
Sometimes, the volume of burnt tokens changes depending on its usage and trades of which it was a part of. In the case of stablecoins, some projects create new tokens whenever funds are deposited into their reserves, while the same amount is burnt after the funds leave the reserves. As you can see, there are multiple methods of doing it, as well as reasons why it is done, and a lot of it depends on the nature of the project and how its developers have organized it.
What is the benefit for token holders?
We also mentioned that token holders could benefit from token burning, and we have already mentioned some cases. For example, the removal of coins can lead to a greater price of remaining units. Apart from that, this method can also be used to stabilize the token’s price, and reduce volatility.
With the token’s price either stable or growing, the token typically sees more use and more purchases, which ensures high cash flow, and keeps the token alive and healthy.
Burning tokens can also be used for increasing transparency. For example, many projects burn the extra tokens after their ICOs to provide their investors with peace of mind, and increase trust in their project. If they were to simply start selling these tokens on exchanges, they would probably find buyers, and make some extra money. However, this would look bad for the project, as it would indicate that it is after money alone.
If the project respects its investors by using the funds for improving business and advancing their operations, this shows that the project is serious and competent, that it has a goal, and that it is sticking to it. This kind of commitment provides reassurance for investors, and the project remains alive and healthy.
As you can see, users can benefit in several ways, from having actual benefits in terms of increased token value, to having moral benefits by seeing that their token’s project is serious about its work. Token holders and token issuers must maintain a relationship based on trust and commitment, which will ensure that the token remains alive, that it will attract new users, and that it will spread around the world, potentially even reaching mass adoption at some point in the future.