Coin Burning: A Guide
Coin burning is a
concept exclusive to the cryptocurrency
marketplaces, having been adopted by a wide range of coins and tokens.
Though it may sound hard core, but coin burning is a central mechanism that
could prove to be a popular feature for cryptocurrency projects down the road.
In fact, many Initial Coin Offerings (ICOs) have integrated a coin
burning mechanism for unsold tokens at the end of their token sale. Not
only that, but major exchanges with their own native tokens –
like Binance – also adopt a periodic token burning mechanism to add
value for those who hold Binance Coin
(BNB).
There are of course,
many motivations for projects to consider a coin burn structure. This guide
will delve lengthily into the mechanics of coin burning to provide a new
outlook on what the future holds for the cryptocurrency marketplace.
Coin burning – as the
name suggest – is a process of intentionally ‘burning’ or eliminating the coins
by rendering it unusable. This is done by sending a portion of the coins to an
‘eater address’, which is often referred to as a ‘black hole’ since the private
keys to that address are not obtainable by anyone. Therefore, any coins sent to
an eater address are unrecoverable and cannot be used again, forever! These
coins are effectively taken out of circulation and is publicly recorded
and verifiable on the blockchain.
Reasons for Coin
Burning
1) MORE EFFECTIVE
CONSENSUS MECHANISM
This applies to coins
that adopt Proof-of-Burn (POB) as their consensus mechanism. POB is a unique way of
achieving consensus in a distributed network, requiring participants – miners
and users – to burn a portion of coins. There are many variations of POB which
will be discussed in the next section.
2) INCREASE VALUE OF
COINS
In order to understand
this, we need to understand the basic economic laws of demand and supply.
Scarcity is a central economic concept that gives value to a
particular asset and in this case, cryptocurrency. Unlike fiat
currencies, cryptocurrencies are deflationary in nature. This means
that the coin supply for most cryptocurrencies are fixed, with no additional
coins created once it has reached its total supply count. The best example
is Bitcoin, which has a fixed supply of only 21 million; if demand
increases, prices would increase since there is a limited number of Bitcoin in
circulation. Likewise, if the supply of Bitcoin
further decreases – due to burning, lost private keys or forgotten
Bitcoins – then prices would similarly increase since there is now a
lesser number of Bitcoins to satisfy people’s demands.
Coin burning reduces
the total supply in circulation since the coin is intentionally destroyed. It
is an effective method of increasing and stabilizing the valuation of coins and
tokens. Economic principles dictate that reducing the quantity of something
makes it much more valuable!
3) PROTECTION AGAINST
SPAM
Coin burning acts as
natural mechanism to safeguard against Distributed Denial of Service Attack (DDOS) and
prevent spam transactions from clogging the network. The same way how users pay
a small fee for sending Bitcoin (BTC) or pay gas for smart contract
computations in the Ethereum blockchain, coin burning creates a cost
for executing a transaction. Instead of paying fees to miners to validate
transactions, some projects have integrated a burning mechanism where a portion
of the amount sent is automatically burnt. Ripple (XRP) is a project that
utilizes this burning model.
4) SIGN OF
LONG-TERM COMMITMENT
Coin burning is an
effective tool to signal a firm commitment by a cryptocurrency project. The
goal of any project is to add significant value to coin holders, who
will probably be the core users and supporters of their service. Employing a
coin burning mechanism to burn excess ICO
tokens or provide periodic burning schedules (by buying back tokens from
the open market using generated profits and thereafter burning them)
would go a long way in reinforcing the project’s growth prospect.
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