Lesson 7: Token burning, friendly fire to stabilise the price of tokens
To demonstrate strength, reduce the number of tokens in order to influence their value or control a cryptocurrency’s inflation. These are some of the reasons for carrying out a token burn—a way to remove digital currencies from circulation and control their price.
Wildfire control experts use a strategy known as “controlled burning” to contain a blaze’s advance and prevent further outbreaks: areas that—in view of wind direction and the specifics of the terrain—are expected to burn, are set alight under supervision. These intentionally burned areas are then gradually doused with water to prevent the main fire from spreading.
When we talk about the crypto ecosystem, token burning could be viewed in a similar way: a process by which cryptocurrencies are removed from circulation—which platforms use to control the value of the remaining tokens. Why choose this solution? What happens to the burned tokens? How does burning affect the market?
The burning of tokens (token burning) is a procedure whereby cryptocurrencies are sent to a wallet to which no one has access, i.e. whose cryptographic keys have been destroyed.
Token burning gets its name by analogy with fiat money burning (illegal in some countries, by the way): in practice, that crypto will not come back, it is lost inside a virtual device that nobody can enter.
Rationale behind token burning
There are several reasons to burn crypto tokens. One is voting, which entails the demonstration of a certain degree power within a platform. In such cases, voters burn part of their tokens to participate in that “democratic” process (one token, one vote).
But the main reason for burning tokens is to influence the value of the token by reducing the number of tokens in circulation. Token burning is carried out with the aim of reducing the amount of tokens in circulation, which in turn usually increases the value of the remaining tokens.
In addition, token burning can be used to control a cryptocurrency’s rate of inflation or to reward existing token holders. For example, if tomorrow 50 % of the world’s gold were to disappear, the remaining gold would be worth more.
Unintentional token burns may also take place
Due to the characteristics of cryptocurrencies, unintentional token burns often occur. If a user loses access to the hard disk containing his or her cryptocurrencies, the cryptocurrencies are unrecoverable. They are, for all practical purposes, “burned” and therefore unusable. In 2021, a highly publicised case was that of a programmer who lost access to his wallet containing 7002 BTC—worth around €200 million at the time. Looked at from this perspective, bank-based crypto-asset custody—such as that offered by BBVA Switzerland—is a key source of certainty.
In 2019, the Tether treasury (a stablecoin) burned around 74 million USDT—equivalent to 74 million US dollars—to stabilise the price at 1 USDT = 1 USD. It is one of the leading stablecoins in the market.
By the end of 2022, Ripple had burned more than 10.7 million XRP since its inception. This free software project stabilises its currency artificially, from an initial 100 million tokens.
An even more radical example of token burning is Binance Coin (BNB), which burns the equivalent of 20 % of its net profits every quarter, providing fuel for the price to rise.