How Does Coin Burning Work? Here’s A Beginner’s Guide.

If cryptocurrencies are digital tokens, how can they be burned? Coin burning is unique to the cryptocurrency market and could become even more popular in the future. Sounds vague and confusing? Here, we’ll discuss what coin burning really is and why burning cryptocurrency is a good idea.

How does coin burning work?

No fires are lit when you burn cryptocurrency coins, but as the term suggests, coin burning would render some coins unusable. Coin burning is a process whereby coins are eliminated after they are sent to a public address or ‘eater address’ which does not have obtainable private keys. When this happens, coins sent to that address can never be used again and are taken out of circulation.

Why should coins be burned?

1) Proof of burn

Proof of burn consensus is an alternative to proof-of-work and proof-of-stake. Since blockchain is a decentralised network, a mechanism is needed to make sure all nodes agree on valid transactions. Usually, the proof-of-work consensus is used and miners use high amounts of computer power to solve a cryptographic puzzle and mine blocks. This method, however, consumes a lot of energy and requires costly hardware devices and Proof of Burn becomes the alternative method for consensus.

When miners send coins to be burned, they show their willingness to suffer a short term loss for long term gain. Burning coins give individuals mining rights. The more coins they burn, the higher chance they would get mining the next block.

Cryptocurrencies which use the proof of burn consensus include Counterparty (XCP and Slimcoin (SLM).

2) Creating scarcity

Coin burning will reduce the total supply of coins in circulation through intentionally eliminating certain coins. Scarcity is key in giving value to assets and coin burning is one way to achieve this. Since supply is reduced through coin burning, prices would increase to keep up with demands. If a crypto company wants to stabilise the valuation of their tokens, coin burning could be one way to achieve this goal.

3) Destroying unsold tokens after an ICO

In some cases, coins are burned if not all of the designated coins are sold after an ICO. Coins usually appreciate in value after an ICO since interest and investments for them increase. If companies keep the unsold coins, it gives them an unfair advantage, allowing them to sell these tokens in the market at a higher price. To prevent this from happening, companies like Beblio burn unsold coins by sending them to an “eater address”.

4) Correct errors

Coin burns are sometimes employed to correct errors in projects. Errors can vary — sometimes, an excessive number of coins are issued or an invalid address for receiving and storing funds could have been created. Since the burning process is simple and quick, these errors can be easily fixed by sending a number of tokens to the “eater address”.

Coin burning might sound quite extreme, especially since these tokens are valued at the exchange market. However, there are many good reasons why firms choose to burn cryptocurrency. Generally, coins are burned as part of an economic policy or an internal mechanism. Firms may want run coins and drive up prices or ensure fairplay after an ICO. More commonly, coins are burned when cryptocurrencies use the Proof of Burn consensus in its network. Proof of Burn is still not the most widely adopted form of consensus but seeing that it requires less energy and is less costly, it has the potential to be increasingly adopted in the future.

 

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