What is Token Burning? Why is it Done and What are its Risks?

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Key Takeaways:


  • Token Burning is a way to reduce overall token supply and influence a token’s value.

  • Securing blockchain networks and rewarding investors are additional reasons for token burning.

  • Token burning comes with drawbacks - market manipulation, rug pulls and the risk of centralization, which investors should be mindful of. 

  • Token burning takes place in millions, billions and trillions in amounts in many major cryptocurrencies.



What is Token Burning?

Token burning is the process of permanently destroying or removing a certain number of crypto or tokens from its circulating supply. This is usually done by sending the tokens to a frozen or burn address.



A burn address is a public address that does not have a private key. In simple terms, all cryptocurrencies are stored in public addresses on their respective blockchains. Each public address has a corresponding private key, much like how a door lock needs a key to unlock it.

However, in the case of a burn address, there is no associated private key. This means no one can access the tokens sent to that address.

Therefore, by sending tokens to a burn address, we effectively destroy the tokens. In simple terms, the tokens become lost without any owner.



Why Burning Tokens are Important

While there are several reasons to burn tokens, one of the main reasons to burn tokens is to influence the value of a certain cryptocurrency or a token. 

We know that value is a function of demand and supply, and when supply is scarce or limited, the value is likely to rise for a certain asset. In the crypto space, this supply is controlled by burning tokens from the circulation. 

Let’s explore several reasons why token burning is important.


Controlling Inflation

When it comes to currencies, inflation means when too much money chases too few goods, making the prices of goods and services higher reducing the value of currencies. 

But when it comes to crypto, this is different. Inflation in crypto means when cryptocurrencies or tokens are minted or created in a way that outpace the demand for it, causing its value to drop. 

The only mechanism to counterbalance this issue is to burn tokens from the circulating supply. When tokens are burnt, supply of tokens gets reduced, helping to control inflation and maintain a stable value. 

Overall, this increases the value of the crypto project. Why? because token burning provides an easy way to manage value by controlling the supply of tokens. 


Rewarding and Incentivizing Stakeholders

When tokens are burnt, the value of existing tokens tends to increase, therefore, token burning is also used as a way to reward long term stakeholders of a cryptocurrency project. 

Not only that, token burning also incentivizes its stakeholders to hold onto their crypto but not sell it. This reduces volatility in the market and maintains price stability and growth. 


Enhance Network Security

Every transaction on a blockchain incurs a transaction fee, typically paid in the blockchain's native token. Token burning ensures that a small portion of this fee is permanently destroyed (burned) rather than being transferred to validators or miners. 

This process serves two key purposes: it discourages spamming by making fake transactions costly and ensures that as the network is used more frequently, the token supply gradually decreases. 

This deflationary effect can increase the token's value over time, aligning the interests of users, investors, and the network's overall health.



The Dark Side of Crypto Burns: Risks and Scams


Market Manipulation

Token burns can sometimes be used to manipulate the market by reducing the supply and influencing the token's price. This can artificially inflate the token's value without reflecting its actual utility or demand. 

Additionally, if insiders are aware of token burns before they occur, they could exploit this information to gain unfair profits.


More Centralization Power

Token burning can lead to developers holding a larger share of a project, concentrating power in their hands.

Imagine a project where the team owns 1 million tokens out of 10 million, which is 10%. This seems reasonable. But if the project burns 5 million tokens over time, the total supply becomes 5 million. Now, the team's 1 million tokens represent 20% of the remaining supply, giving them more control.

This shows how burning tokens can misleadingly increase developers’ influence, undermining the project's decentralization.


Rug Pulls

Project developers can use crypto burns to mislead their community by claiming to burn tokens. For example, they can fake the token burns by sending the tokens to a public address that only they control and later sell it at a higher price for profit and completely abandon the project.

This tactic could leave investors with worthless tokens, so to avoid such scams always do your own research - review the project white paper, research the project team, investors etc. 



Different Types of Crypto Burns


Manual Burns 

The project team or the governing body decides to burn the token manually. For example, Binance conducts quarterly burns of its token BNB.


Automatic Burns

These token burns occur when predefined conditions are met in blockchains or in smart contracts. For example, Ethereum EIP-1559 upgrade, where a portion of transaction fees is burned with every transaction.


Buyback and Burn

Projects use their revenue to buy tokens from the open market and then burn them. This helps to directly impact the token’s price and reduce supply. 

For example, in 2021, Crypto.com repurchased and burned 70 billion CRO tokens as part of its strategy to reduce circulating supply and enhance token scarcity.



Top Cryptocurrency Burns: Notable Examples


Binance Coin (BNB)

Binance regularly burns BNB tokens every quarter based on trading volume. Over the years, billions of BNB have been burned to reduce supply and potentially increase the token's value.


Shiba Inu (SHIB)

Shiba Inu, a popular meme coin in the crypto space, conducted a significant burn of 410 trillion SHIB tokens in 2021. They have continued to burn tokens over time to reduce supply and potentially increase the value of the remaining tokens.


Tron (TRX)

A blockchain based platform for decentralized applications, burned a large number of TRX tokens to reduce supply and increase scarcity. In 2018, they burned 1 billion TRX tokens as part of this strategy.


Stellar (XLM)

In November 2019, the Stellar Development Foundation (SDF) burned 55 billion XLM tokens, more than half of the total supply, to realign its resources and reduce the overall token supply.



Final Thoughts

Token burning is a powerful tool to influence the value of any cryptocurrency by reducing its supply. When used ethically, it can create scarcity, increase demand, and reward long-term holders. However, it’s important for investors to be aware of how burning is implemented and whether it aligns with the project’s goals.

While token burns can benefit a crypto project, they can also be misused to centralize power or mislead the community. Conducting thorough research before investing in a cryptocurrency is essential.

Transparency from project teams regarding burn processes and their impact on token distribution can help identify promising projects.

Understanding the mechanics and implications of token burning is key to making informed investment decisions and avoiding potential pitfalls in the crypto space.

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