Coin Burning: How Is It Done & Why?


The cryptocurrency burn has been in the spotlight for the past few weeks, mainly due to the incessant burning of Shiba Inu (SHIB) tokens. The developers of this meme coin are on a fiery spree to save the coin from devaluation in a highly volatile crypto market. Nearly 260 billion SHIB tokens worth $25,000 have been burned so far, and a new burn mechanism is also underway to further this strategy.

But what is coin burning?

When it is said that a certain number of crypto tokens were burned, it means that they have been permanently withdrawn from circulation. This is done by simply transferring those tokens to a ‘dead wallet’. The private key of this wallet is unknown, so the crypto is lost forever.

But why would developers burn their cryptocurrencies?

When there is an excessive flow of cryptocurrencies in the market, the price of that token stays low since the demand never exceeds the supply. In such a scenario, burning a portion of the cryptocurrency acts as a ‘deflationary’ move. The scarcity of the token increases and triggers a price appreciation of the remaining tokens in circulation.

One of the most famous crypto burns was when Ryoshi, the creator of Shiba Inu Aliased, gave Ethereum founder Vitalik Buterin 50% of the SHIB supply at his launch. However, in 2021, Buterin burned 90% of his tokens and donated the rest to charity, claiming that he did not want to become “the center of power”. The burned tokens were estimated to be worth $6 billion at the time and would have been worth trillions of dollars now.

But what happens under the hood of a burning transaction? How are these coins burned? Well, coin burns can be segregated into two main categories, which are:

one. Protocol level mechanisms:

Proof of Burn (PoB): This consensus mechanism requires users to stake their coins to become validators for the network. However, the staked coins are sent to a dead wallet, after which they can no longer be accessed or spent. The more coins you burn, the higher your chances of becoming a validator.

Having burned their coins, users can qualify as validators and receive newly minted coins for each block they verify and add to the blockchain. These mining rewards should appreciate over time due to the continuous burning of coins as part of the network’s consensus mechanism (users constantly burn their coins to qualify as validators).

Burns per transaction: Cryptocurrencies like Ripple (XRP) are coded to burn a fixed number of tokens as part of each transaction. It is usually taken from gas fees paid by the transactor and redirected to the flare address. While gas fees ensure legitimate transactions take place, burning a small portion ensures that the token retains its value.

two. Economic stability movements:

Unsold coin burns in ICO: New tokens are launched in an Initial Coin Offering (ICO), in which investors bid to gain ownership of the tokens. However, some tokens may be left unsold at the end of the event. Developers can decide to dispose of these tokens by burning them. This results in a significant price increase for existing owners and developers themselves. It is also a sign of the developers’ commitment to the long-term goals of the project.

Dividend burning: This is a mechanism to reward existing token holders. Blockchains like Binance implement the buy-and-burn strategy where they buy back some tokens from the open market (at market prices) and burn them. The price appreciation from this move acts as a dividend reward for investors holding that token.

The blockchain periodically burns its native tokens to maintain or improve their value. This periodic burning is achieved using a ‘burn function’. This smart contract automatically sends a specified number of tokens in circulation to the recording address. Binance aims to eventually wipe out 50% of its volume with this strategy.

One of the biggest crypto burns in history is that of the Terra network in November 2021. Terra burned 88.7 million LUNA tokens, which amounted to $4.5 billion back then. Terra also burned a further 29 million LUNA tokens worth $2.57 billion in February 2022.

The burning of cryptocurrencies has only one purpose: an increase in the value of each remaining token. Sometimes developers announce a big crypto burn, but instead of sending the assets to a dead wallet, they just redirect them to a controlled wallet that can be used for nefarious purposes. This is why due diligence is essential before investing in any cryptocurrency.