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Posted bySeven Capitals

What Does it Mean to Burn Crypto?

POSTED ON MARCH 29 2024

When it comes to the price of anything, supply and demand play a huge role. The more a commodity is in supply, the less the demand for the same and the price of the commodity will drop either. On the other hand, if the supply of a commodity is less, the demand for the same will increase, thereby increasing its prices as well. The same theory of supply and demand is applicable in the world of cryptocurrencies too. First of all, the maximum supply of most of the crypto coins are limited to a specific number. Still, that number is huge for many crypto coins, and when more tokens are mined and the number of coins in circulation exceeds too much, there is a need for reducing the number of coins in circulation, to bring the balance back to the supply and demand equation. This balancing out act will eventually increase the price of the remaining crypto tokens, which are now less in number. To accomplish this, the process of crypto burning is normally conducted. 

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What is crypto burning? 


Crypto burning is the process of “burning” crypto coins to erase them out of circulation. Conceptually, it is similar to burning real currency notes, which will stop the same from circulation, but the process is a bit different as digital currencies are involved here. To do this, developers take the initiative often. They buy back crypto coins from the crypto market, and remove them from circulation, through a process often called burning. This increases the value of a single cryptocurrency, as the decrease in supply obviously increases the price, and the overall value of their holdings get a hike too. 

How does Crypto Burning work ?

One of the major ways to burn crypto coins is for the holders to voluntarily send the crypto coins to a burn address. Developers often give back rewards for such burning, including the right to verify the next block in the blockchain network. This is called proof of burn, a consensus mechanism that is used to replace the energy-consuming proof of work mechanism and the less-secure proof of stake mechanism. When the crypto coins are sent to an address with no keys to access the same, they are non-retrievable and are banned from circulation forever. This can be done using a smart contract that removes a particular number of tokens from circulation forever. 

Why do companies burn crypto?


Companies burn crypto for several reasons such as increase the value of their tokens, give rights to the users the right to create the new blocks, to manage the possibility of inflation, etc. Regulating the number of tokens in circulation is not a new concept. Central banks always try to regulate the amount of currencies in circulation, to avoid inflation and deflation. Likewise, major publicly listed companies sometimes buy back their stocks to regulate the number of stocks in circulation for the public to trade. This may increase demand through invented scarcity and leads to the increase in stock prices. 

There are also certain crypto projects that automatically burn the cryptocurrencies generated from transaction fees. This prompts the buyers from engaging in regular transactions and holding more on to the coins they traded. Also, ardent followers of a cryptocurrency project may get a confidence boost when a company burns tokens, as they might feel like the company is more than willing to do what’s necessary for the long-term success of the project. 

Conclusion 

Generally, companies or developers of cryptocurrency burn tokens with a long term vision in mind. It is to decrease the total number of tokens in circulation and thereby increase the value of a single token. Since August 2021, Ethereum has burned more than 5 billion dollars worth of their cryptocurrency, taking them out of circulation forever. Crypto coins are also burned by users as part of proof of burn consensus mechanism, to receive benefits and rewards from the developers. Proof of burn is also a low-energy consensus mechanism, unlike the common PoS and PoW mechanisms. But, the number one drawback of crypto tokens is the wastage of resources forever, even though it has its benefits. Also, burning may in the end have little to no effect on the price of the token. Also, there are the possibilities of counterfeiting the burned coins. 

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