The governance of many industry projects makes the choice to burn part of their cryptocurrency. ETH, BNB or SHIB, some of the most valued cryptocurrencies on the market use this mechanism. But what exactly is a token burn? What are the reasons for such a choice? Presentation of a practice highly appreciated by investors.
What is a token burn?
A “burn” refers to the mechanism by which the units of a cryptocurrency are burned, that is, destroyed, in an intentional and permanent manner.
As a result, a burn reduces the current supply of the cryptocurrency since the total number of tokens available decreases.
It is a deflationary process, in opposition to the issuance of tokens (mint), which occurs as a reward for mining or validation of a block according to the blockchain on which a cryptocurrency operates.
A burn does not literally imply the destruction of tokens, it is only figuratively. Indeed, concretely, the process by which tokens are burned is to send them to a “dead wallet”. The particularity of such a portfolio lies in the absence of a private key, which means that it is impossible to access it and will therefore be inactive forever.
Once the tokens are sent to a dead wallet, it is impossible to recover them. If a comparison is necessary, just imagine locking cash in a safe that does not have an access code from its design, making it impossible to unlock.
There is another way in which tokens can be lost forever, and it is not to be confused with a burn
These are human errors, in fact, if we make the wrong address when we try to send funds or if we lose access to a wallet, these tokens will be lost forever, even if the number of tokens in circulation will not officially decrease.
The different types of burn
There are many ways to burn tokens. Ethereum and EIP-1559 automatically burn part of the network transaction costs.
Another example is Binance’s NBB. This is one of the best-known cryptocurrencies in the industry when we mention the burn mechanism.
Indeed, since October 2017 and until the end of 2021, each quarter, the Binance platform used 20% of its profits to buy NBBs at the market price (see strike price) and burn them.
The particularity of the NBB lies in Binance’s commitment from the beginning of the project to burn NBBs in this way until 50% of the initial outstanding offer, i.e. 100 million BNB tokens, is burned.
This market-in-market redemption therefore acts as a way to reward holders of BNB tokens.
However, since January 2022 (18th burn), the combustion mechanism of BNB tokens has evolved and Binance has introduced auto-burn. This new mechanism uses a mathematical formula taking into account the total number of blocks generated and the average price of the NBB over the quarter.
Another type of burn takes place within the framework of algorithmic stablecoins. These have a system with two cryptocurrencies, in which one absorbs the volatility of the other, the stablecoin.
To do this, the outstanding offer of the two cryptocurrencies is elastic: this implies a burn mechanism on one of the two cryptocurrencies in opposition to the issuance of new tokens from the other cryptocurrency, in order to stabilize the price of the stablecoin (check alchemy pay price).
It should be noted that even in this type of burn, the main objective is to increase the value of the cryptocurrency absorbing volatility.
Finally, anyone can concretely burn tokens, for whatever reason, by sending them himself to a dead wallet.
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