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Bitcoin is the main cryptocurrency many people know, understand, and are familiar with. It is also one of the few digital currencies that has no individual or group that is in charge of the blockchain project. What has come about since Bitcoin was created is a cryptocurrency ecosystem where there are a number of companies in charge of blockchain token projects.
These companies, while still running decentralized cryptocurrencies, do step in to make adjustments to the projects on an ongoing basis, and one of these actions is known as a ‘coin burn’.
This is a fairly straightforward and common action whereby a coin’s developing team or organization intentionally destroys coins to take them out of circulation, with the intention of forcing a lower supply. While there are other reasons for these burns as well, it is predominantly a mechanism of deflation.
Coin burns are unique to the cryptocurrency market as traditional fiat currencies cannot be destroyed in this manner. However, the approach can be likened to share buybacks by publicly owned companies, which reduce the amount of stock available.
How to Burn a Digital Token
Just like how Bitcoin isn’t really a ‘coin’, a token burn does not need any fire. However, there is an action taken by the token developers where the tokens’ signatures are put into an irretrievable public wallet known as an ‘eater address’. This address can be seen by all nodes but is practically frozen forever.
This is the most common way to burn a token, but there are some subtle variations in terms of how often, and when, the tokens are burnt. Then there are also stablecoins to consider as these are usually backed by a real-world currency or an asset. Tether, for example, will take the reserve currency out of the ecosystem and burn the tokens, in the same manner, using an eater address.
Why Burn at All?
As mentioned previously, burning tokens is a deflationary move to ensure that the value of the token does not drop due to increased circulation from mining or new minting. Simply put, lower supply usually means higher demand, and higher demand can drive the price of a token up.
Beating inflation like this is key as a currency that starts to hyperinflate can be devastating. In Argentina, for example, the Argentine peso is suffering from a strong bout of inflation in an uncertain market prompting its citizens to look to Bitcoin for its deflationary properties.
The importance of keeping the value of a token high, and growing, by monitoring and adjusting the supply on an ongoing basis is that it incentivizes more support from the community. This is one way that a project can control the price of their coin, and thus keep parties interested.
In essence, this process is intended to mostly be of benefit to the project as their token becomes more valuable and incentives more support. It can also help increase its notoriety and position the token as one on the move, but this is of course also beneficial for the token investors.
Burning tokens also helps stabilize the value of a coin and lower the volatile price swings, so it is not only about quick gains. A stable value also pushes investors to more of a holding strategy than a trading strategy, and having investors hold coins keeps network uptime and bandwidth healthy.
Coins are also often burned at the end of ICOs as a way to remain fair and transparent in the eyes of the ICO investors. After an ICO, it is expected the value of the coins will start to rise or investors would not buy in. But, there are often coins left over with the company that created them. Instead of reaping an unfair advantage by selling these coins after the ICO at a better price, companies rather burn them as an act of good faith to investors.
Coin burns are unique to cryptocurrency and show a system where the deflation of a currency or asset is prized. This is in stark contrast to fiat currencies, especially at the moment, where dollars, euros, yen, and a number of other major currencies are being printed in their trillions.
This floods the currency market and causes inflation in an exactly opposite manner to the cryptocurrency token burn. Inflation is a danger for currencies as it devalues them significantly, and this is why cryptocurrencies that go with a token burn are looking to take advantage of deflation.