What is a token burn?

"token burn” means permanently withdrawing a certain number of tokens from circulation. This is usually done by transferring the tokens in question to a burn address, i.e. a wallet from which they can never be retrieved. This is often described as token destruction.

A project burns its tokens to reduce the overall supply. In other words, it creates an event " deflationary ". The motivation is often to increase the value of the remaining tokens, as the price of assets tends to rise whenever the circulating supply decreases and they become scarce.

In this article Finance de Demain explains the fundamentals of token burn. But before, here is a paid training that allows you to get started with online training.

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What is token burn?

There are cryptocurrencies that can be mined. This increases the total supply (i.e. the number of coins in circulation). Some of these digital currencies have a cap that is set as soon as the currency is created. This is the case of Bitcoin, whose maximum number of coins is set at 21 million (there are currently 17 million bitcoins in circulation and we should expect 20 million in 2030).

Other assets can also be mined and have no cap. This is the case of Ethereum. About 10 million new ethers are mined every year. There were approximately 100 million Ether in circulation in 2018 and this number will continue to increase by approximately 10 million every year.

We saw together in a previous article, the concept of mining which consists of creating new coins. In this other article, we will see that the number of parts can also decrease over time. This is token burn. The decrease in units of a crypto-currency over time can happen in two ways:

️ Because of the user: By sending cryptos to the wrong address

By losing access to its exchanges, its physical storage media or even its addresses containing its tokens. In these cases, the number of tokens in circulation will not decrease since they still exist, but they will be unusable because no one will be able to move or use them.

️ When the issuing company of a cryptocurrency decides, by doing what is called a burn

The total number of circulating tokens of a cryptocurrency may be reduced due to user error or as a result of a decision made by the token-issuing company through what is called a burn. Both will lower the total supply, but tokens lost by users will still be considered in circulation according to the site. coinmarketcap.

Burn translates to “brûlage” in French and would mean destroying something by fire. The English term has another connotation and rather means that something is simply destroyed.

How does the token burn take place?

The destruction of real banknotes is something easy to imagine, but how to achieve such a result with cryptocurrencies?

Token burning is ultimately a fairly simple practice. It is enough for the people in charge of the token burn to send a determined quantity of cryptocurrency units on a address (eating address). That is to say a portfolio of cryptos that does not belong to anyone, and which is locked.

The wallet in question is an address that has no key, which means that no one will ever be able to access the cryptos stored there, and that they are as if destroyed. The addresses of these wallets are public and the transactions can be viewed by anyone.

However, there are not only advantages to token burning. Practice alone does not guarantee that the remaining cryptocurrencies will increase in value, especially if the blockchain is not well known. And the associated benefits do not necessarily last over time. After the Stellar token burn in 2019, the value of XLM gradually fell, until it again reached the level before the burn.

The different types of token burn

There are 3 main types of token burn:

♦️ The one decided in advance in the white paper of the project. This can be done on a fixed date or when certain conditions are met.

♦️ The one that occurs when a user uses its tokens to perform a specific action. For example by buying a product with its tokens. It may be that the company has decided that X% of the tokens will be burned after each purchase.

♦️ The Unplanned token burn and which will arrive after a decision taken by the issuing company. For example, to try to draw attention to the project or when the total supply is deemed too large.

Each of these different ways to burn will reduce the total number of tokens in circulation. This will be taken into account by the Coinmarkercap site when the total supply data is verified.

Interest of burning tokens

There are different reasons that can lead a cryptocurrency issuing company to reduce its total supply. Here are a few :

♦️ To stay in accordance with their white paper. If it was part of their basic plan, then they have to stick to it. Otherwise, they may lose the trust of users who have invested based on this document.

♦️ When team members own too much of the supply. If the team behind the project has too large a percentage of the tokens, then it will put off a lot of people from investing in it. In order to attract capital, the team can unilaterally decide to burn part of its tokens.

♦️ In order to make increase the value of its tokens. It's the old law of supply and demand that applies here. At the rarer a product and the higher its demand, the greater its value.

What pushes leaders to burn tokens?

• Change in prices following a token burning
• Economic law applied to the scarcity of a token

Each time the total supply of a cryptocurrency decreases, its token will become increasingly rare. According to a fundamental law of economics, the rarer a good is, the more its value increases with constant demand. This therefore means that at most the lower the total supply of a cryptocurrency, the higher its price should be.

According to this economic law that we have just applied to crypto-currencies, we realize that a burn of tokens should therefore, logically, lead to an increase in the price of this crypto-asset. But is this really the case in practice?

The problem with the cryptocurrency market is its incredible volatility. So if a token burn occurs, it must be significant enough and/or expected by the community for it to be noticeable on the course of this crypto-asset. If it happens little by little, nothing will be detected.

Binance Coin (BNB) burn case study

Let's analyze through this example the effect that a token burn will have on the price of the crypto-asset.

Binance has already conducted a burn of its tokens 4 times : October 18, 2017, January 18, 2018, April 18, 2018 and July 18, 2018. Now let's see what happened on the chart around these dates (announcements were made around the 15th each time).

Chart analysis:

• During the burn announceOctober 2017, we notice that the market reacted well and that the token gained a lot of value over a short period.
• We notice a similar behavior during the January 2018 burn, despite the strong bear market at the time.
• When for his april burn 2018, things are a bit different. After several months of decline, bitcoin recovered during this period. During the rise of Bitcoin, we notice a general decline in all altcoins (in satoshi value). We note that the BNB remained stable during this period (in satoshi). Which is a pretty good sign compared to other currencies.
• In July 2018, the market was strongly bearish and we noticed a small jump during the burn. This proves once again that it is beneficial for the valuation of an asset.

Studying the case of Binance and taking into account the state of the market, we therefore notice that the announcement of a burn is immediately beneficial for the value of a crypto-asset. Please do not generalize this example. A burn may have no effect on the price of a cryptocurrency. But before you leave, here is premium training that will help you take control of your personal finances.