Cryptocurrency has become increasingly popular in the last few years, with many people across the globe either using or owning crypto coins. Perhaps this is because it is often viewed as a cheaper alternative solution to sending and receiving money across borders.
And today, most people are pretty aware of what cryptocurrency is and the chances are high that you might have bought bitcoin at some point. Even so, you might not know much about the different trading strategies used in the crypto market. And one common strategy used by cryptocurrency platforms is coin burn!
So, what does a coin burn mean with cryptocurrencies?
In simple terms, coin burning refers to a process of intentionally removing or eliminating crypto coins from the market and rendering them unusable or unobtainable. This is usually achieved by sending a portion of the coins to the so-called eater address, which is commonly referred to as a black hole because the private keys to this particular address are not accessible to anyone.
This implies the crypto coins that are sent to an eater address can’t be recovered and cannot be used again, forever! Burned coins are legally taken out of circulation and are publicly recorded and provable on the blockchain.
It is worth noting that cryptocurrencies aren’t the first to discover or use coin burning a strategy. In fact, this concept is strikingly similar to the idea of a publicly traded company buying back its stock. Such companies usually use cash on hand to purchase back shares of common stock, and as a result, reducing the total amount of outstanding shares.
This strategy helps to boost the value of those shares that are remaining in circulation and can equally improve earnings per share because, with fewer outstanding shares, the net income to shares ratio becomes relatively higher.
In cryptocurrency, coin burning aims to accomplish a similar objective. By minimizing the number of crypto coins in supply, miners and developers generally intend to make the coins that remain in circulation hard to find, or rarer and make them more valuable as a result. But how is this achieved in cryptocurrency markets?
In the digital currency arena, it is quite difficult to regulate the flow of tokens or crypto coins once they have been mined. To remove coins from circulation, developers and miners acquire those coins and then send them back to specialized addresses with unobtainable private keys.
And without access to a private key, you won’t be able to access these burned coins to utilize them for transactions. As a result, these burned crypto coins become unusable and for all purposes and intents, relegated to a private space outside of the circulating supply.
So, how does the coin burning process work in cryptocurrency?
First and foremost, it is imperative to note that there is no standard procedure for the process of coin burning. However, one common and major requirement is that the tokens must be permanently unobtainable after the process. And because most cryptocurrencies are committed to the virtue of transparency, burned crypto coins are put in an irretrievable public address referred to as eater addresses.
This means that this type of wallet can be viewed by every public participant even though it is technically frozen. All in all, a specific procedure is often followed to ensure the whole coin burning process is permanent and irreversible.
There are different procedures employed in the burning of crypto coins, which vary depending on the primary purpose of the process. Whereas some crypto markets will adopt a one-off burn after the end of the initial coin offer, or ICO to eliminate unsold coins or tokens from the market, others prefer to burn coins periodically at variable or fixed intervals.
Generally speaking, a typical coin burning process involves the following key steps:
A crypto coin holder will initiate the burn function, outlining that he or she wants to burn a specified amount of tokens.
The crypto platform will then confirm that indeed the person has the said coins in his or her wallet. It is worth noting that only positive numbers count! And this simply implies that if the stated number is insufficient or invalid, the burn function will not be executed.
And if there are enough coins in their wallet, then the requested coins will be subtracted from those wallets. After that, the total supply of the coins will be updated and the coins will subsequently be burned. And you can’t recover the coins once they have been burned
So what are the reasons why the coin burn strategy is used in the cryptocurrency markets?
It is somehow difficult to fully digest the concept of coin burning if you don’t know the law of supply and demand. The idea is straightforward and simple! It is aimed at creating an economic scenario where the asset, in this regard cryptocurrency, will become scarce and forcing its demand to increase.
Generally, scarcity is a widely accepted economic strategy that increases the value of a particular asset and in this case, crypto coins. Like any other thing, a coin burning strategy is aimed at providing value to the entire cryptocurrency network. Below are the potential benefits of coin burning:
It boosts the value of crypto coins:
As we have just explained above, cryptocurrencies employ the market economy’s principles to determine the price from demand and supply. As you already know, the scarcity of a particular asset is a key determinant of its price. Compared to their fiat money counterparts, cryptocurrencies are generally deflationary.
This implies that the coin supply for most crypto coins is fixed, with no extra tokens created after it has its limit of total supply count. A typical example is Bitcoin that has a fixed supply of twenty-one million only. This implies that if its demand increases, its price would equally increase because there is a limited number of bitcoin available in the market.
In the same way, if the supply of cryptocurrencies is reduced through coin burning, the prices will eventually increase simply because we now have a lesser amount of cryptocurrencies to satisfy the demands of users. Coin burning is a strategy that minimizes the total supply of crypto coins in circulation because the coin is intentionally eliminated from the market. It is a highly effective strategy for stabilizing and increasing the value of coins.
It offers protection against scam:
Besides increasing the value of coins, coin burning also helps safeguard against DDOS (Distributed Denial of Service Attacks) and bar spam transactions from clogging the crypto network or market.
The same way a crypto trader pays a certain fee to send a crypto coin, coin burning ensures you incur a certain cost for executing a transaction. Instead of paying minors some fees to validate a transaction, some crypto firms have an integrated coin burning mechanism that ensures a certain portion of the overall amount is burnt automatically.
Requiring a cost to execute transactions is a key aspect for any blockchain to help prevent spam transactions from compromising the network. This implies that for each transaction that occurs on the network, a small number of tokens is burnt. Traders, therefore, indirectly pay for the cost of carrying out a transaction.
Through this approach, the whole network benefits from the improved value of the coins because the supply of native coins decreases with time, which will ultimately boost prices in the future.
In a coin burn model, the cost that a trader indirectly pays for removing the coin from the network is a value-boosting proposition for all the users in that particular network because the overall supply is reduced. Therefore, we can conclude that the coin burning strategy is a somewhat fairer and equitable way of sharing value to all the players in that particular network.
To enhance trust and confidence!
In the cryptocurrency trading world, trust and confidence are key elements, especially on the part of traders. Coin burning is an effective tool for instilling confidence and trust in customers. It signals a level of commitment by a cryptocurrency project.
All cryptocurrency projects aim at adding some form of value to their coin holders and to ensure they can remain long-term users and supporters of the network. Employing a coin burning strategy allows for these aspirations to be achieved because it helps provide the new investors with the certainty that the value of their coins will never be impacted by an over circulation.
It is used to destroy unsold coins or tokens:
The coin burning strategy can also be used to remove the unsold tokens from circulation. This is usually done to guarantee fair play. On most occasions, not all tokens or coins that are designated for sale get sold. It is also worth noting that coins generally appreciate in value after a major coin sale.
And in a situation where not all tokens are sold, it somehow gives some sort of an unfair advantage of extra money, which they can get by selling the unsold tokens in the free market at an inflated price!
To help prevent such a scenario from occurring, the unsold coins are sent to an unobtainable address where they can never be used again.
The Bottom line:
Generally, cryptocurrency is a highly risky and speculative venture, and anyone who wants to invest in the digital currency trade needs to conduct thorough research before making any move.
And while coin burning is generally a beneficial strategy for both the cryptocurrency network and the traders, it doesn’t always guarantee that you’ll benefit from it as a trader! Generally, it can be a great technique in preserving wealth for all the players in a particular crypto network.