What Does It Mean to Burn Crypto?
The concept of "burning" cryptocurrency refers to the permanent removal of a certain quantity of tokens from circulation. Typically, this process involves transferring the specified tokens to a burn address or a wallet from which retrieval is impossible. Commonly referred to as token destruction, this practice serves various purposes within the cryptocurrency ecosystem.
One primary reason for burning tokens is to decrease the total supply of a cryptocurrency. By doing so, a project initiates a deflationary mechanism, aiming to enhance the value of the remaining tokens. This strategy takes advantage of the economic principle that asset scarcity often leads to an increase in value, as observed when circulating supplies decrease.
Algorithmic stablecoins employ a similar technique by routinely minting and burning tokens to maintain their pegged value to a specific fiat currency. For instance, if demand for a stablecoin surges and its price exceeds the peg, the underlying protocol's smart contract generates additional tokens to stabilize the price, and vice versa.
Drawing an analogy to corporate finance, burning tokens can be likened to a company repurchasing its own shares, effectively returning value to its shareholders. In the realm of cryptocurrency, projects resort to token burning to achieve a similar outcome. However, it's important to note that the immediate price impact following a token burn might not be significant. Other concurrent developments or market factors can overshadow this event, or investors might anticipate the burn and incorporate its effects into the price earlier.
Nevertheless, over the long term, token burning generally provides support for a cryptocurrency's value, often considered a favorable strategic move. This practice can also benefit participants engaged in staking tokens for transaction validation in proof-of-stake protocols. When a substantial amount of tokens is permanently removed from circulation, stakers could potentially receive greater rewards in terms of their U.S. dollar value.
Certain cryptocurrency projects incorporate regular token burning events into their code to reassure prospective investors about the diminishing future supply. This practice addresses concerns of inflation and an oversaturated market. Consequently, this approach contributes to positioning the token as a reliable "store of value," thereby boosting its appeal.
An illustrative case is the Terra project, which executed a substantial token burn in November 2021. The initiative involved the permanent removal of 88.7 million LUNA tokens, valued at approximately $4.5 billion at the time. The Terra community sanctioned this action through a vote. Subsequently, the price of the LUNA token reached a new all-time high in the days following the burn. The rationale behind this burn included reducing the value within Terra's community pool, a step advocated by founder Do Kwon, who believed the excess value was unnecessary in that pool. Effectively, the burn transitioned value from the communal pool to individual token holders.