Token burn or coin burn is a phenomenon when token developers or miners remove tokens or coins from circulation. By doing this, they slow down inflation by reducing the total circulating supply of tokens in the market.
Burning can be done with almost all cryptocurrencies, and because of this feature, many investors hold cryptocurrencies to hedge against inflation. Inflation occurs when more money is being printed, leading to a higher supply of money in the economy which causes the value of money to drop. Burning tokens is the opposite – deflationary.
How does token burning work?
The main objective of token burns is to reduce the existing supply of tokens in the market, therefore, slowing inflation of the token, or in many cases causing deflation.
This might seem straightforward but can be done by various methods. Some projects burn tokens that were not sold during token sales, some burn tokens on a periodic basis and other burn tokens when a transaction is performed.
Burn per transaction
For example, in Ethereum’s London Fork upgrade, a portion of transaction fees will be burnt. With a higher burn vs mining rate, this reduces the amount of circulation supply of Ethereum in the market which can cause an increase in the value of ETH.
How this happens is when a transaction is executed on the Ethereum Network, a portion of the transaction fee is sent to a wallet address with no private keys. Doing this effectively removes these tokens from circulation.
The process is transparent and anyone can view the address of the burned tokens.
Buying back tokens
When a company does a share buyback, it’s a similar action as token burning because shares that were bought back are kept in the custody of the company The effect of a share buyback is to reduce the number of outstanding shares on the market, which increases the ownership stake of the remaining shareholders. A company might buy back shares because to increase its own equity value, to invest in itself, or to improve its financial ratios. In the crypto space, tokens that are bought back are typically burnt.
Huobi Global does a monthly burn of Huobi Token to control the inflation of Huobi Token. For example, by August 2021, more than 280 million HT had been burnt. This brought the current HT circulation down to 205 million with a deflation rate of 1.63% for that burn event.
These results can be seen by anyone on the blockchain, and it shows the number of tokens burnt so far vs the total supply.
The opposite of Inflation
Removing tokens from circulation reduces the supply available and, given that demand stays constant, leads to an increase in token value. Conversely, when central banks print more fiat there is a higher circulation of fiat in the market, reducing the value of fiat. For example, the inflation rate in Venezuela was about 2,500% in 2021, while global inflation was an average of 3.2%. For the Venezuelans, and everyone else in the world, holding on to Bolivars or fiat money means that they lose purchasing power every day.
Token burning is one of the key mechanisms that investors look at to determine if a project has the ability to counter inflation. With an ever-shrinking supply of tokens in the market, owning these tokens can result in better yields for investors.
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