By Larry Wright
The crypto industry is a numbing place to be a part of, especially if you don’t know a lot about what is going around you, then you clearly don’t belong here. That is why consistent education is important to make sure that you don’t only understand the terms that are thrown your way but are actually comfortable with these moving forward.
You might have heard a lot about blockchain technology, decentralization, mining, staking, non-fungible tokens, decentralized apps, and many other terms as well. Now you might know all of these or a few of these or none of these, depending upon your level of attachment to the crypto market, but if you are a trader, then you really need to understand these terms in detail along with a few others such as coin burning.
Now you might be thinking that coin burning might mean the actual burning of coins in some kind of furnace with fire and stuff, but that is not the case, it is much more delicate than that, and it is extremely important that you understand this specific term before moving forward if you wish to become a successful trader within the crypto market. So without further ado, let’s get right into it and dissect the term token burning.
Coin burning correlates to a process in which certain cryptocurrencies belonging to a particular domain of blockchain technology are permanently removed from the system and circulation, which ultimately results in the reduction of the total supply available. You can take into account any particular crypto out there or the blockchain technology which supports its minting. But for the sake of argument, let’s say that we are taking the Binance Coin into account as an example to make you understand what coin burning is and how the process commences.
In events of a burning process, the admins of a dedicated blocking network have the authority to remove certain tokens from circulation, which would definitely decrease the supply for that particular token.
These tokens, once burned or removed from circulation, are then sent to a particular wallet address which cannot be approached or used for the sake of transactions or anything, but its sole purpose is to receive the burned tokens. The wallet is placed outside of the network for safety reasons, and the tokens that are placed there cannot be used any longer.
Importance of Crypto Coin Burning
There is a particular address that is assigned to a crypto user who wishes to either send or receive tokens over the network; think of this address as an email address that can both receive and send an email at the same time. The catch here is that you can be anywhere on the planet, and using just an active internet connection and having a computer by your side, you would be able to use that email address for its original purpose, which is sending and receiving emails.
The crypto address, on the other hand, works in a similar fashion, the network itself recognizes the address, and when you send a request to either receive or send crypto, it validates the address first, and then the transaction is taken under processing, this is also your wallet address. When it comes to the burning of tokens, there is only one wallet there with a singular function and which is to receive crypto tokens and nothing else; this is done in events of coin burning.
You can call that particular address a heater or a burner address. In the case of normal crypto wallets, you are awarded a particular private key which can be used for the sake of opening it up and using it in events of either sending or receiving a token, but when it comes to the burner wallets, these don’t have any private key whatsoever which means that once a token is submitted to these particular wallets, it is gone forever.
This is a rather smart approach if you truly think about it because it is a wallet that works like a black hole having so much density and gravity that literally pulls an unimaginable number of tokens in and never lets this out.
Use Cases of Coin Burning
Next up, we have some of the most elegant applications in store for coin burning; you might be wondering that when coins are burned, the supply receives a pretty great push back, meaning that it is decreased but kicks up the overall value of the said token. Yes, it is one way to look at the situation, but there are other practical applications for coin burning that must be taken into account.
Being able to remove a dedicated asset from circulation to adjust the availability and decrease the volatility of the said asset is not an entirely new concept because it has been in practice for centuries. Lots of coins, paper notes, and other such elements have gone out of circulation because their use case ended, and people were just not feeling at home with those assets, or a dedicated country or government deemed it fit that these assets must be taken out of circulation for some other reason.
The Central Bank of a country typically adjusts the overall amount of currency that is in circulation for the sake of adjusting the purchasing power of the said country. In the same way, cryptocurrencies are shutting off excessive tokens from their blockchain technology to make sure that the overall circulation of the token is under check at all times and the available supply is adjusted in the best way possible. There are some other practical use cases with this concept which will be discussed as follows.
Does Coin Burning Pump Price Values of Cryptocurrencies?
To be able to better understand this concept, you must take into account the example of companies that are publicly traded. These companies have their shares thrown out into the stock market, and these are available for anyone to purchase; each share makes the shareholder a practical partner of the said company in a capacity that represents the total number of shares bought.
When this publicly-traded company sees that the overall number of shares is declining within their ownership, they try to buy back those stocks to reduce the circulation and gain power. This typically increases the overall value of the shares while boosting the financial performance of the said company. But to assume that it would always work like this is a mistake because, unfortunately, it doesn’t.
This might sometimes have the opposite effect. Some companies buy their shares back to have some sense of control or to make sure that an illicit takeover can be avoided; this way company decides to have the majority in terms of shares that it is holding so no one else has the voting power above the company itself.
The burning of tokens provides the crypto token in question with similar results. When the entities who are burning these tokens reduce the supply, they are assuming that this will ultimately increase the value of their token while making them less attainable at the same time; this is a kind of control that is practiced by the entity in charge to control the main supply of the token and increasing the present value of the asset as well.
Sometimes burning of tokens is indeed a necessity, whereas other times, developers do this intentionally to accomplish these tasks, which include increasing the value of the token itself, making it more valuable while at the same time putting a leash on the overall circulation of the token in effect.
What is Proof of Burn (PoB)?
If you have ever dealt with cryptocurrencies in the past, then you know that each and every one is unique in its own function and proposes a different consensus mechanism or algorithm for its smooth functioning. What the majority of people don’t know is that a single cryptocurrency could utilize more than one consensus algorithm to sustain its functioning and remain efficient.
Multiple cryptocurrencies, along with their main consensus algorithm, utilize proof of burn, which is another consensus algorithm ensuring the smooth and efficient burning of tokens when initiated by the administrator of the network. This is to make sure that all the participated nodes completely agree to a valid state of the blockchain network that is also presumed true.
A consensus mechanism might bring into account revelation from multiple validators out there to make sure that a transaction is indeed valid. Most of the time, the proof of burn consensus algorithm is also termed as proof of work on account of its being energy efficient. It proposes a separate domain that allows miners out there to be able to burn a vast amount of crypto tokens and then subject these tokens into a wallet that can only conceal the token but can’t let it go.
After each and every miner has contributed to this agreed-upon burning of tokens, they will receive rewards in the form of the native token in proportion to the overall number of coins that were burned. These mined and burned tokens are then sent to the receiving wallet by the validators of the network in question to make sure that this will remain encapsulated in that particular wallet and out of the reach of the mainnet of the blockchain so that no one, even by mistake comes around these coins because these are not in circulation anymore and have no ties with the original network itself.
This process actually doesn’t require any energy sources at all, which is why the whole thing is termed as extremely energy efficient, but some segment of energy still is required to burn these tokens off because susceptible mining of these tokens must also take place before these can be burned, this is to make sure that the network has a record of these tokens which were burnt to make sure that the whole thing remains agile and active.
The validators who are put in charge of burning these tokens also receive a proportionate amount of reward for this; if you are burning these tokens as a validator, then you would be receiving the same native cryptocurrency for your services. All of this burning activity makes the token more valuable in the long run and keep the agile network while at the same time rewarding the participants who took part in the validation of the burning process for that particular crypto coin.
There are many validators who would prefer to be chosen by the network for this specific task other than validating actual transactions because this way they are doing less job, which is to mine the crypto first and then subject it into a definitive block which would ultimately be sent off to wallet which only accepts incoming and where outgoing isn’t an option. This cuts the job of the validator in half, and the reward fraction, however, remains the same, which is why it is a much more efficient and lucrative opportunity for any validator out there.
These participants are awarded not only for the burning of their own tokens but for taking up the task of burning tokens of other users who are not validators per se within the network, it is kind of a nicer version of being a validator for a dedicated blockchain.
Coin Burning and Mining
It was a common and systematic element within the blockchain world that people who got earlier access to a cryptocurrency during its very prime stage were able to reap more benefits as the rewards when crypto is simply starting are extremely high. To prevent this unfair taking-off advantage for these early adopters, the proof of burn consensus mechanism induces systematic burning of crypto tokens to have a periodic balance between early and new mining adopters.
This means that even if you are a pioneer validator for a dedicated cryptocurrency, you would be treated the same as a new member who has just joined the network as a validator a few seconds ago.
Whenever a new block gets mined, the very velocity at which tokens are developed through the proof of work consensus mechanism gradually reduces. This demands consistent activity by the validators because here, instead of mining a single token when mining had first started, these miners now must burn away their previous tokens and get down to mining new ones to sustain their profits.
The new proof of work mining algorithm makes it extremely complicated to be able to mine away new tokens as more and more are being created, so eventually, it becomes hard for early investors or people who have invested a huge chunk of money in developing large mining farms to be able to maintain a consistent and immediate supply of these tokens.
As tokens are burned, the previous ones that the miners hold by solving the complex arrays of mathematical equations become worthless because these are to be burned, and in place of these, new ones must be minted. This is a really classic way of making sure that both the previous users and the new ones have a fair head-to-head competition without giving any kind of value to the earlier adopters or snatching up ground from the new ones.
Pros and Cons of Crypto Coin Burning
The very purpose behind the burning of cryptocurrency is to make sure that these tokens are abruptly taken out of circulation and are no longer part of whatever blockchain these earlier belonged to. This creates a sense of value and efficiency to properly run the blockchain environment whereas doubling or even tripling the present value of the tokens for that specific blockchain.
If something is scarce and is nowhere to be found, its demand is only going to increase in the future, and this is the perfect way to do just that but in a completely arbitrary and artificial way.
Sometimes crypto burning works and is the best thing that you can do to double or even triple up the price of your tokens that you’re offering at the moment, but at other times it might backfire, and the whole thing will just run like a chaotic machine who’s off switch is broken.
Therefore caution is advised here, and if you are the administrator of a dedicated blockchain network, then you really know what you are doing, so to get an opinion on this statement that whether it is a good thing or a bad thing, it is basically something that is based on your own perspective or what you want to make out of it.
The supply and demand dynamic is an extremely thin line sometimes; it organically occurs, which means that there might be little shortage of one cryptocurrency within the market, whereas the shortage for another crypto is being introduced in a non-organic way; you must know when to play your cards, and if you play your cards right then it is extremely pleasant and a super thing which you can do but if you don’t then it is a checkmate.