Anybody involved with the cryptocurrency industry would have definitely come across the term “token burning”. As the name seems to imply, the process involves the permanent removal of a fixed number of tokens from a project’s existing circulation pool either by transferring the coins to a ‘burn address’, i.e. a wallet from which they cannot ever be retrieved, or via a process referred to as a ‘buy-back’, wherein the issuer purchases a set number tokens from the market and lock them up, essentially rendering them useless.
Also, it is worth mentioning that token burns can be carried out in a number of different ways. For example, while some companies can choose to carry out the process as a one-off event there are other firms like Binance, OKEx that host burn events at regular time intervals. The reason can vary from firm to firm, depending on what they are trying to achieve. For example, one-off burns are most usually done to eliminate excess tokens that may be left over as part of fundraisers, pre-sale events, or to rectify some accidental minting issues.
For example, a couple of years ago Tether ended up accidentally issuing $5 billion worth of its USDT stablecoin, resulting in the token being destabilized from its 1:1 US Dollar peg. However, the tokens were swiftly burned and removed from circulation leading to no major long term issues.
The pros of burning tokens…
The fact that token burning is an extremely common activity seems to raise the obvious question “What exactly is the use of a burn event apart from it being used to correct minting errors or removing tokens from circulation?”.
In this regard, it should be noted that token burning serves as a “deflationary mechanism” that has a direct impact on the price of a digital asset. As an analogy, we can compare the process to Bitcoin’s halving event, wherein the cryptocurrency’s reward supply ratio is cut by half every four years, leading to its value increasing in line with the laws of supply and demand.
Burning tokens, much like halving, serves as a means of restricting a currency’s total supply pool. To this point, if the market demand for an asset remains the same or surges over time, thanks to its limited availability, its price will go up. This is in direct opposition to how the traditional finance system works, wherein a centralized banking authority has the power to print money ad infinitum, thus diluting its purchasing power over time.
There are many crypto projects that make use of this process. For example, Safuu, a DeFi protocol that provides investors with seamless auto-staking and auto-compounding capabilities, regularly burns its native crypto asset — $SAAFU — so as to manage its circulating supply. As a result, the platform is able to deliver extremely high annual percentage yields (APYs) that are paid out daily.
To elaborate, the protocol features a financial module called the ‘Fire Pit’ that is designed to prevent $SAAFU’s pool size from becoming unmanageable while also serving as an ideal means of offsetting its positive rebase interest printing. To this point, the Fire Pit routinely takes 2.5% of all traded $SAFUU and burns them. Therefore, as more and more tokens are traded, the more the volume of $SAAFU that is taken out of circulation, allowing for the protocol to remain stable while delivering high yield ratios.
The bottom line
There’s no denying the fact that token burning can be extremely beneficial when used correctly, since the process allows for the alleviation of many inflation-centric pain points plaguing the market today — all while incentivizing users to hold on to their digital assets.
Therefore, as we head into a future driven increasingly by cryptocurrencies, it stands to reason that more people will move away from the trad-fi economy, which is debt-based by its very nature, and gravitate towards the use of deflationary assets whose values increase, not slide, over time.