When you read a headline saying that a company has “burned” half its coins, as Stellar recently did, what actually happens? Why would a company destroy its assets in this way, and how does the process work technically?
Let’s start with the technicalities. When coins are burned, they’re permanently taken out of circulation. With physical money, that can be done physically: notes are burned, coins are melted down. (In reality, the supply of fiat currencies almost always increases rather than falls.)
But digital assets rely on cryptography for their existence. Once they’ve been created by an irreversible, unhackable cryptographic process, how can they then be destroyed?
They can’t. Instead, the company that owns the coins sends them to a wallet address that doesn’t have a private key.
That means everyone in the network can verify that the transfer has taken place, but no-one can access the coins again because to do so would require a private key.
Why would a company burn coins, though?
There are several reasons. Nearly all of them boil down to deflation.
Anyone who watches the progress of fiat money over time can see the effects of inflation. A dollar now is worth a fraction of what it was 100 years ago. One of the appeals of digital assets to investors is that they don’t depreciate due to inflation in ordinary use. There can sometimes be an inflationary risk, and founders thus sometimes burn tokens to reassure investors and maintain the token’s value. This risk can arise when there are more tokens available than expected, or when residual tokens remain after a sale.
How and why do burns take place?
Binance carries out quarterly burns, running their eighth in July 2019 and their tenth in January 2020 when the company burned 2,216,888 BNB. The effect of this burn was to permanently remove about 38.8 million USD worth of BNB from circulation.
The company has announced a commitment to burn 100 million BNB tokens.
Burning tokens in this way makes the Binance network more profitable, and BNB trading volume and prices typically rise immediately after burns as well as more long-term rises.
Burning tokens after an ICO
A company conducting an ICO would like to sell all its tokens. However, that’s rarely the case. There’s nearly always a residuum of unsold tokens. The company then has the choice to keep, burn or airdrop those tokens.
It’s common to burn remaining tokens on conclusion of an ICO, as a means of keeping the value of purchased tokens the same as when they were bought. Some ICOs will airdrop remaining tokens onto prior investors while others will use a combination of these strategies.
Correcting errors with token burns
Tether is pegged 1:1 with the US dollar. That’s the whole point of its existence. So when the company accidentally created $5 billion worth of USDT, it couldn’t release them without destroying its pegging. Instead the tokens were burned to retain the exchange rate.
Burning securities tokens
Securities tokens represent expected profit in a project. They can be thought of as digital shares, though that’s not an entirely accurate analogy. Token burns of securities tokens function somewhat like corporate share buybacks: coins can be bought back at a fair rate and burned to increase the value of the remaining coins. This can profit both the owners of the project, and investors who have bought securities tokens.
Some networks conduct limited burns to improve security. For instance Ripple burns network fees to help protect against system overload and DDoS attacks by making them prohibitively expensive.