What Is Cryptocurrency Burning?
Cryptocurrency burning is the process in which users can remove tokens (also called coins) from circulation, which reduces the number of coins in use. The tokens are sent to a wallet address that cannot be used for transactions other than receiving the coins. The wallet is outside the network, and the tokens can no longer be used.
- "Burning" a cryptocurrency refers to the act of sending a token to an account that can only receive them.
- Wallet addresses used for burning cryptocurrency are called "burner" or "eater" addresses.
- The act of burning effectively removes tokens from the available supply, which decreases the number in circulation.
Understanding Cryptocurrency Burning
Cryptocurrency users are assigned an address used to send and receive coins. You can think of the address like an email address. You can send and receive emails from that email address anywhere you have access to it. A cryptocurrency address is similar—the cryptocurrency network recognizes that address as yours and uses it for transactions. This is your wallet address.
Cryptocurrency is "burned" when a coin is sent to a wallet address that can only receive coins. These addresses are also called "eater" or "burner" addresses. Cryptocurrency wallets have private keys that let you access the token you have stored in them; however, burner addresses do not have a private key, which means the tokens are gone forever.
Practical Applications for Coin Burning
Removing an asset from circulation to adjust availability and value is not a new concept. For example, central banks adjust the amount of circulating currency to adjust that currency's purchasing power. There are a few other practical reasons for burning cryptocurrency.
Intentional Burns to Increase Value
Publicly traded companies buy back stock to reduce the number of shares in circulation. In general, this practice is intended to increase the value of the shares while increasing the company's financial performance. Unfortunately, it doesn't always work as intended and sometimes has the opposite effect. Shares are also repurchased as a method of control—companies can use this tactic to prevent a hostile takeover—the act of buying shares to gain a majority and thus ownership of the company.
There is no evidence yet that burning cryptocurrency tokens increases the value of that specific cryptocurrency. The action can influence investor and user sentiment which would have more of an effect of driving prices up and down.
It is thought that tokens are burned to achieve similar results. By reducing the number of coins in supply, the entities doing the burning hope to make the tokens more valuable and less attainable—working to control the coin supply and maintain or increase the value of their own holdings. Some cryptocurrency developers intentionally burn tokens to accomplish these tasks.
Proof-of-burn (PoB) is one of the several consensus mechanism algorithms implemented by a blockchain network to ensure that all participating nodes agree to the true and valid state of the blockchain network. A consensus mechanism is a set of protocols that use multiple validators to agree that a transaction is valid.
PoB is often called a proof-of-work system without energy waste. It operates on the principle of allowing miners to burn virtual currency tokens. They are then granted the right to write blocks (mine) in proportion to the coins burnt.
To burn the coins, miners send them to a burner address. This process does not consume many resources—other than the energy used to mine the coins before burning them—and ensures that the network remains active and agile. Depending upon the implementation, you're allowed to burn the native currency or the currency of an alternate chain, such as Bitcoin. In exchange, you receive a reward in the native currency token of the blockchain.
You can send out transactions to the network that will burn your coins. Other participants can mine/burn on top of your block, and you can also take the transactions of other participants to add them to your block.
Essentially, all of this burning activity keeps the network agile, and participants are rewarded for their activities (both burning their coins and the coins of others).
Burning to Promote Mining Balance
To prevent the possibility of unfair advantages for early adopters, the PoB system has implemented a mechanism that promotes the periodic burning of cryptocurrency coins to maintain a balance between early mining adopters and new users.
The speed at which coins are created through PoW reduces each time a new block is mined. This promotes regular activity by the miners; instead of mining one coin when mining first begins, miners must burn their early coins and mine new ones. Because new proof-of-work mining makes it harder to mine new coins as more are created, it becomes more difficult for the early investors—or well-funded ones with large mining farms—to maintain a majority of the coins.
Is Burning Cryptocurrency Good or Bad?
Cryptocurrency burning takes tokens out of circulation. Similar to corporate stock buy-backs, it can be beneficial for the cryptocurrency or backfire, depending on investor and user sentiments and how the new supply and demand dynamics influence prices.
How Do You Burn Cryptocurrency Tokens?
Tokens are burned by sending them to a wallet address that can only receive tokens, but not send any. This removes them from circulation, or "burns" them.
Why Do Companies Burn Cryptocurrency?
In general, it's the developers that burn tokens. This reduces the supply, which theoretically acts to increase the currency's price and benefit investors.
Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns Bitcoin and Ripple.