Token or cryptocurrency destruction refers to a mechanism that permanently eliminates tokens from the circulating supply.
The cryptocurrency market has boomed over the past decade, with many tokens valued at billions of dollars.
As the market grows exponentially, many expect many of the thousands of tokens to fail or continue to drop in value, but this rarely happens, especially among the top 100 tokens, some of which have their value controlled with the help of burning tokens.
Since the advent of cryptocurrency, many projects have adopted this mechanism to artificially create token scarcity and thus drive up prices, but this not-so-new concept is gaining popularity as many crypto communities and users embrace it.
That said, the process of token burning varies from project to project, and it’s important to fully understand how a project’s token burn will affect you and what it means. In this article below, we’ll dive into what a cryptocurrency burn is, how it works, the history of token burns, and some real-world examples of how token burns have been performed in the past.
What is token burning?
Token burning, or "burning" for short, is a mechanism used by crypto projects to permanently eliminate/destroy (burn) a large number of tokens from the existing circulating token supply. This is usually done by sending the number of tokens to a burn address, which is a digital wallet that cannot be accessed by anyone because it does not have the private key. This reduces the number of tokens in circulation, locking them up permanently and preventing anyone from accessing them, thus creating a "deflationary" event.
The main reason for burning tokens is to increase the value of the remaining tokens. This follows the principle of supply and demand economics, which states that if the supply of tokens in circulation decreases while demand remains the same (or increases), it will lead to scarcity of the asset; therefore, a higher price for the asset.
Conversely, by increasing the number of tokens in circulation while demand remains constant, the price of the asset could experience a decrease in value.
Burning tokens creates scarcity, which in turn, may increase the value of the asset and people will trade it. Additionally, token burns also welcome new investors as they are seen as a bullish indicator, again boosting demand.
Over the years, multiple projects including Ethereum, Binance Coin (BNB), Shiba Inu, SWEAT Economy, and hundreds of others have adopted this approach to increase their value. While a burn may be seen as bullish, it is not always immediately reflected in the price, as some token burns occur automatically and regularly or are disclosed in advance, meaning the price will be effectively priced in before the token burn occurs.
Importance of Token Burning
As mentioned earlier, token burning is an effective way for crypto projects to reduce the total supply of tokens in circulation. Reducing supply makes them more scarce and potentially valuable, which can create a positive feedback loop where prices surge and more investors join the bandwagon, further increasing demand.
Secondly, a planned destruction schedule, such as the BNB quarterly destruction, provides a more balanced ecosystem for the BNB ecosystem. By burning cryptocurrency, the project reduces the advantage of early miners or investors over new users of the token. As the coins decrease, the blockchain network benefits investors equally, providing more value to every investor in the project.
Third, burning tokens also increases trust in the developers, demonstrating their commitment to the project. How? As mentioned above, burning tokens demonstrates that the developers are willing to reduce the number of tokens and sacrifice their own supply (or floating supply) to bring greater benefits to investors.
Finally, some projects apply a set schedule for burning tokens, known as Proof of Burn (PoB), which is one of the consensus algorithms that ensures that all participating nodes in the network verify the state of the blockchain. PoB operates on the principle of miners, and sometimes, investors vote to destroy these tokens. Once destroyed, miners have the opportunity to mint the same proportion of the destroyed tokens.
A key example is the recent governance vote of SWEAT Economy, which allowed investors and token holders to vote to destroy $100 million of SWEAT tokens or distribute them to existing token holders.
Real-world examples of token burning
As mentioned above, coin burns are almost like cryptocurrency itself. In fact, some of the earliest and most successful projects have used coin burns as part of their strategy. Below, we’ll discuss some real examples of some of the most famous coin burns in cryptocurrency history:
Burning "wrongly"
Although it goes almost unnoticed, false destruction is one of the most popular ways of destroying coins. For example, Bitcoin is arguably the first and most famous example of these "false" destructions. Whenever a user loses their private keys or sends coins to an inaccessible (invalid) wallet address, those BTC are effectively destroyed as they will never be accessible again. It is estimated that over 4 million BTC have been effectively destroyed, which is 20% of the total supply.
Buyback and Burn (BNB)
The Binance Coin (BNB) destruction schedule involves a buyback and burn mechanism where the project uses part of its revenue or profits to buy back tokens from the market and destroy them. This increases demand and reduces supply, creating upward pressure on prices.
When BNB was launched in 2017, it was promised that 100 million BNB (half of its total supply) would be removed from circulation through a burning process. The most recent burn (the 23rd burn) saw 2,020,132.25 BNB (about $676,744,304) burned.
Fee Burning (ETH)
As Ethereum transitioned from Proof of Work (PoW) to its Proof of Stake (PoS) consensus algorithm, the community decided to destroy a portion of the fees collected. The EIP-1559 update introduced in August 2021 destroyed Ether from the fees collected from validating and verifying the network.
According to Beaconcha, as of this writing, 3,252,529.9 ETH (about $5,931,837,296.25) has been destroyed, reducing the number of ETH tokens in circulation since August 2021. The designated destroy address is 0x000000000000000000000000000000000000000000000 and has no private key, meaning any tokens sent there will be effectively destroyed.
Governance Burn (Sweat tokens)
Crypto governance has been a thing since the launch of decentralized autonomous organizations (DAOs) in 2015, giving token holders the power to decide how a platform progresses. While some tokens are planned to be burned, platforms like MakerDAO allow the community to choose whether to do so.
Of the available token burn mechanisms, governance voting token burns create the most trusted and interesting type of token burns. Simply put, the community votes in a democratic manner to decide whether and how much tokens to burn.
One of the most interesting token burns that has been conducted recently via decentralized governance voting is the April governance vote for the SWEAT token. Unlike other burn schedules that vote exclusively on token burns, SWEAT introduced a token and distribution governance vote that allowed the community to vote by April 25th on whether to burn 100 million SWEAT tokens or distribute them to users with 12-month growth jars.
As expected, the community was split when it came to choosing one of the two options. A total of 153,783 users participated in the vote, of which 91,481 users (59.487%) voted for distribution and 62,302 users (40.513%) voted for token burn. In the unprecedented vote, 100 million SWEAT tokens were distributed as decided by voters, with 59,541,465.013 SWEAT distributed and 40,549,975.987 $SWEAT burned.
"It was cool to vote in the app and be transparent about the results. I'd definitely like a contract next time," shared another SWEAT voter.
NFTb, an NFT protocol built on the BNB chain, conducted its first DAO-sanctioned token burn in January, allowing the community to choose how many NFTbs the protocol would burn. The community had to choose what portion of the total token supply to burn, with choices including 5%, 15%, and 25%. The community chose to burn 25% of the tokens, resulting in a 4x increase in price.
Algorithmic stablecoin token destruction (Terra stablecoin, UST)
Finally, algorithmic stablecoins also perform automatic token destruction to control the supply of their tokens. For example, if the demand for algorithmic tokens rises and the price loses its peg and exceeds $1, the platform will automatically mint new tokens and put them on the market in large quantities until the price falls back to $1. Conversely, if the demand for tokens falls and the price falls below $1, the platform will automatically buy back tokens and destroy them until the price rises back to $1.
One of the most notable algorithmic stablecoin destructions was Terra’s UST token, which broke out in early 2022. To keep the price of UST stable, Terra Network used its native cryptocurrency LUNA. If the price of UST was above $1, users could burn LUNA tokens to mint UST, increasing the supply and effectively bringing UST back to $1, and vice versa. However, once the price of LUNA plummeted in mid-2022, UST fell with it — investors lost more than $60 billion.
Meme Money Burning (SHIBA INU)
The recent increase in interest in meme coins such as Dogecoin, Shiba Inu, and Pepe has seen some projects choose to burn their tokens to reduce over-inflated supplies. Late last month, Shiba Inu (the second-largest meme coin) announced that it had completed the largest daily token burn ever, sending a record 41 million SHIB tokens to a burn address in a single day on May 24.
Shiba Inu has had an interesting burn rate schedule since the first burn, when Ethereum founder Vitalik Buterin destroyed more than 90% of the SHIB tokens received from the creators of Shiba Inu. In May 2021, Vitalik decided to destroy about 410 trillion SHIB tokens (40% of the total SHIB supply), which was one of the greatest moments of the token. After Vitalik destroyed the SHIB tokens, the Shiba Inu price increased by nearly 40%.
in conclusion
Token burning is a powerful mechanism for creating value and utility for crypto tokens.
By reducing the supply of tokens and increasing the demand for tokens, token burning can increase their price and scarcity. Nevertheless, token destruction also has potential risks, such as whales taking advantage of token destruction, and once the token price rises a little, they will sell the tokens, affecting the value growth of the token.
Additionally, some untrustworthy platforms may deceive their community by promising to destroy tokens, but in reality, they send the tokens to an accessible wallet.