Explained | Coin Burning: How is it done & why? (2024)

Crypto burning has been in the spotlight over the last few weeks, mostly due to the incessant burning of Shiba Inu tokens (SHIB). The developers of this meme coin are on a burning spree to save the coin from devaluation in a highly volatile crypto market. So far, close to 260 billion SHIB tokens worth $25,000 have been burnt, and a new burning mechanism is also underway to take this strategy forward.

But what is coin burning?

When a certain number of crypto tokens are said to be burnt, it means they have been permanently pulled out of circulation. This is done by simply transferring those tokens to a ‘dead wallet’. The private key for this wallet is unknown, so the crypto is lost forever.

But why would developers burn their cryptocurrency?

When there is excessive cryptocurrency flowing in the market, the price of that token remains low as the demand never exceeds the supply. In such a scenario, burning a portion of the cryptocurrency acts as a ‘deflationary’ move. The scarcity of the token rises and triggers a price appreciation of the remaining tokens in circulation.

One of the most famous crypto burns was when Ryoshi, the Aliased creator of the Shiba Inu, gave Ethereum founder Vitalik Buterin 50% of the SHIB supply upon its launch. However, in 2021, Buterin burnt 90% of his tokens and donated the remaining to charity, citing that he did not want to become “the locus of power”. The burnt tokens were estimated to be worth $6 billion then and would have been worth trillions of dollars now.

But what goes on under the hood of a burn transaction? How are these coins burnt? Well, coin burns can be segregated into two main categories, they are:

1.Protocol Level Mechanisms:

Proof-of-Burn (PoB): This consensus mechanism requires users to stake their coins to become network validators. However, the staked coins are sent to a dead wallet, after which, they can no longer be accessed or spent. The more coins you burn, the higher your chances of becoming a validator.

Having burnt their coins, the users can qualify as validators and receive newly minted coins for every block they verify and add to the blockchain. These mining rewards should then appreciate over time due to the continuous burning of coins as part of the network’s consensus mechanism (users are constantly burning their coins to qualify as validators).

Per-Transaction Burns: Cryptocurrencies like Ripple (XRP) are coded to burn a fixed number of tokens as a part of every transaction. It is usually taken from gas fees paid by the transactor and gets redirected to the burn address. While the gas fees ensure that legitimate transactions go through, burning a small portion ensures that the token upholds its value.

2.Economic Stability Moves:

Unsold Coin Burns at ICO: New tokens are launched at an Initial Coin Offering (ICO), wherein investors bid to gain ownership of the tokens. However, some tokens may remain unsold at the end of the event. Developers can decide to get rid of these tokens by burning them. This results in a significant price increase for existing owners and the developers themselves. It is also a sign of the developers’ commitment to the long-term goals of the project.

Dividend Burns: This is a mechanism to reward existing token holders. Blockchains like Binance implement the buyback-and-burn strategy wherein they repurchase some tokens from the open market (at market prices) and burn them. The price appreciation from this move acts as a dividend reward for the investors holding that token.

The blockchain periodically burns its native tokens to sustain or enhance their value. This periodic burning is achieved by using a ‘burn function’. This smart contract automatically sends a specific number of circulating tokens to the burn address. Binance aims to eventually eliminate 50% of its volume with this strategy.

One of the most significant crypto burns in history is that of the Terra network in November 2021. Terra burnt 88.7 million LUNA tokens which amounted to $4.5 billion back then. Terra also burnt 29 million more LUNA tokens worth $2.57 billion in February 2022.

Crypto burning serves only one purpose -- an increase in the value of each remaining token. Sometimes developers announce a vast crypto burn, but instead of sending the assets to a dead wallet, they just redirect them to a controlled wallet which can be used for nefarious purposes. This is why due diligence is critical before investing in any cryptocurrency.