Token Burning: What is it, Why do it?

Beginner Mar 11, 2022 · 5 min read

Key Takeaways:
— Crypto’s defining feature is freedom – and that means not just freedom to own digital assets, but also to destroy them. But why do this?

— Projects and individuals burn tokens to for a number of reasons, but the core aim is always the same – impacting value via supply.

— Stability is another end that token burning can achieve. Algorithmic stablecoins control the supply of their tokens in an innovative approach to creating stability, the foundation of DeFi 2.0

— Meanwhile burning can also be used in the art sector to play with our notions of value and fungibility, something that is driving interesting new projects.

— Bottom line – token burning is an important concept. Let’s get to know it.

Token burning means destroying a coin or token permanently – but why do this? It’s a great question, and here we have your answer.

Among many revolutionary features, perhaps the most appealing aspect of crypto currency is the control it restores to users. 

Blockchain technology provides you the ability to have absolute ownership over your assets, and this can be seen in a number of areas; you don’t need a bank or financial institution to send and receive value, your transactions can’t be limited by third parties – and even the supply itself is a vector where users enjoy more autonomy than with traditional money, not only because many tokens have a limited supply, but also because you, the user, have the power to destroy tokens. But why do this?

Here, we explain the practice of token burning, its various use cases within the crypto ecosystem, and  dynamics to be aware of.

What is token burning?

First, let’s nail the basics – what exactly are we talking about? Burning a token means permanently destroying it.  This can be done (by anyone) by sending it (or whatever quantity of tokens you’re burning)  to a frozen private address (also called a burn address) which, if authentic, is an address from which the coins cannot be recovered. 

By definition,  a true burn address has no private key. Since a private key is needed to access the coins at a given address, this means no one will  have access to coins in this wallet.

In short, token burning is the digital equivalent of stashing a ton of money in a safe and locking it without knowing the access code. 

Why would anyone destroy tokens?

That’s a great question – and the answer can be found with a quick recap of the dynamics of supply and demand.

Value is a function of both supply and demand. The higher the demand for a given asset, generally the higher its value. And conversely, the lower the supply, the higher its value. So where the supply of a given coin or token is fixed (Bitcoin is a prime example of this, with the underlying smart contract ensuring on 21 million BTC can ever be generated) there is scope to impact its value by destroying some of that supply. 

This can be utilized for a number of ends, including increasing token value, producing value stability or in some cases, being creative with the concept of value, as we’re currently seeing with some clever NFT art collections.

Let’s look at some key use cases for token burning, to get a better understanding of this dynamic in action.

To Increase Project Value: Ethereum

Impacting value via supply is not a new concept, especially when it comes to finance. Corporate buy backs are commonplace for public companies, and entail the company buying back some of their own stocks and shares from the market, in a bid to increase the value of the remaining supply. You can think of token burning as the crypto version of a buy back – let’s have a look at this in action.

In 2021 Ethereum bought back and burned 1.3 Million ETH from the network’s circulation.The aim of the burn – and others like it, carried out as part of a recent protocol upgrade – is to make ETH a deflationary currency. In other words, to ensure ethereum tokens can be an effective store of value, and even increase in value over time, by reducing their supply.

To Stabilize Value: Olympus DAO

Stablecoins are an essential part of the crypto and DeFi ecosystem, providing a medium for both settlement and HODLing that is insulated from the volatility of regular coins and tokens

But this requires a compromise:  the stability of stablecoins stems from the use of a central reserve, which is vulnerable to regulation, mismanagement and error which are all the things crypto is meant to resolve.  

Algorithmic stablecoins seek to overcome this by creating coins of stable value via control of the supply.

One good example of this is Olympus DAO. It’s native currency OHM is managed by an algorithm that adjusts the circulating OHM supply to control the value of the token. If the price of OHM drops below a certain point (the value of 1 DAI) the algorithm will automatically burn some of its supply to maintain price parity with DAI. Conversely, if the price exceeds this level, new tokens will be minted and added to the supply to stabilize the token value. This process called “rebasing” and is the foundation for a raft of stablecoin innovation in DeFi 2.0.

And it is another key example of how token burning can be utilised to control crypto value.

Curated Extinction: Token Burning for Art

“Burn art to get ashes, to get art to burn art.” 

If you’ve never heard of Pak, consider this a fitting introduction to one of the most avant garde artists/social commentators/enigmas of our generation.

In April 2021, NFT artist Pak launched a platform called burn.art which allows anyone to burn NFTs in exchange for the cryptocurrency “ASH.”  The point? It was sort of a game that played with the idea of scarcity by adding fungible possibilities to non-fungible assets, enabling collectors to decide the value of the art and the tokens.

If you own an NFT you have the option to essentially burn it in exchange it for an ASH token – you’ll lose that NFT and any personal gain from it, but in so doing you’ll not only get a stake in ASH, you’ll also decrease the supply of that NFT collection, pushing the value of the collection up as a whole (at least in theory). So the project poses some pretty deep questions about the value of art, the value of money and your personal values.

And what about ASH tokens themselves? Holding ASH permits burn.art users to buy and sell digital assets on the platform. Generating a unique medium of exchange on burn.art is a case study on the power of creative tokenomics.  Paks project proves that blockchain is a place where individuals can exercise some personal control over value, create niche ecosystems and trade their assets and intellectual property without the sluggish constraints of fiat currency.

Token Burning for Individuals

One final point. Token burning can be used by absolutely anyone who owns private keys for a given token – in theory it could be used to simply get rid of unwanted tokens received in drops. The underlying importance is that crypto empowers users (and projects) a truer form of ownership by enabling us to play with supply, and this gives rise to a host of new possibilities.

Things to be aware of

As we’ve seen, having full control over a token supply means some interesting new vectors for creativity, problem solving and personal autonomy, but there are also some new things to be aware of as a user when sizing up a new project.

Hiding Whales

Burn wallets can be used as a way to hide large holders or “whales” who own large portions of a project’s tokens. Here’s an example: imagine a project developer told the community that the leadership team only owns 1,000,000 out of the 10,000,000 coins issued – sounds like a reasonable share, right? But immediately, the team burns 6,000,000 of the remaining coins, leaving them with a 25% share of the whole project. Such a centralized ownership makes a project more vulnerable, and also centralizes control in the hands of just a few.

Rug Pulls

Project developers can mislead their community by claiming that coins are being burned while, in reality, the coins are being sent to a wallet which they control. Once the price increases, the developers could sell off their coins and walk away with a hefty profit, leaving remaining stake holders with worthless tokens. This is just one variation of a rug pull.

There are several ways to reduce the risk of being scammed in the crypto space, but the best method is to conduct as much research as possible into the founding members, smart contracts, and whitepaper of a project. The crypto community is relatively new and being well informed can protect you from bad actors who lurk in the shadows. 

Taking Control

Control of the money supply has traditionally rested exclusively with central entities. But increasingly, the decentralized nature of blockchain means projects themselves, artists and even regular people like you and me can use supply as a vector to impact the value of what we hold.

We’re not suggesting you burn your favorite Bored Ape just yet, of course! Simply that we acknowledge this very interesting concept, where ownership means the ability to both create and destroy. Token burning is not just about getting rid of tokens, but is part of a broader story in which control in various forms is being passed back to people, and this will surely give rise to some interesting, useful and thought provoking blockchain developments for those who understand its utility.

Knowledge is power.

If you’re interested in token burning, you need to know about smart contracts. Here is your ten minute crash course on this key crypto concept – thanks School of Block.

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