What is token burning?
Token burning refers to the process in which a certain amount of cryptocurrency is intentionally removed from circulation, reducing the total supply of available tokens.
Imagine a popular restaurant that takes some tables out of the dining area to make it feel more valuable and exclusive with a limited number of tables. Similarly, cryptocurrency token burning reduces the total supply of tokens, which can potentially increase the value of those that remain.
To burn tokens, a project sends them to a unique wallet address that can only receive tokens but never send them out. This makes those tokens permanently inaccessible — like locking them in a random and resistant-to-hacking wallet with an unknown private key.
Typically, the project or community decides on the address to ensure it is random, resistant to hacking and entirely inaccessible. Since no one can retrieve or spend these tokens, they are considered permanently “burned.”
Token burning is often done by cryptocurrency projects to control supply and create scarcity, attracting investors and stabilizing the market. While some traditional companies achieve a similar effect by buying back their shares to reduce the number in circulation, token burning is unique to the cryptocurrency world and reflects a project’s commitment to long-term goals.
By permanently removing a portion of tokens from circulation, burning can make each token more valuable, similar to how limited edition items get appeal when their availability decreases. This scarcity can attract investors while rewarding existing holders with potential value appreciation, ultimately reflecting the project’s commitment to long-term goals.
Token burning is seen as a strategic move to increase a token’s value by shifting the supply-and-demand balance. While not all tokens employ this method, it is common among smaller or newly emerging token projects in an attempt to stabilize their market and gain investors’ trust.
How token burning works
Token burning isn’t just a symbolic gesture; it’s a carefully controlled process that makes those tokens permanently untradeable.
The token burn process involves a series of steps that ensure tokens are permanently removed from circulation, with each step playing a crucial role in making those tokens untradeable.
Step 1: The decision to burn tokens
First, a decision to burn tokens usually comes from the project developers or governing bodies. They may burn tokens as part of an economic strategy to increase scarcity or as a response to community input.
Some projects adopt deflationary mechanisms, where tokens are periodically burned to reduce supply over time. Others design tokens with built-in burn mechanics, such as burning a percentage of transaction fees or staking rewards.
Projects burn tokens in different ways. Some use scheduled burns, like Binance’s quarterly token burns, adjusted by trading volume. Others use transaction-based burns, where fees are permanently removed from circulation with every transaction. For example, Ripple burns a fraction of its transaction fees as part of its mechanism to prevent spam on the network, making its approach distinct from scheduled token burns like Binance’s.
Unlike other cryptocurrencies, stablecoins like Tether’s USDt (USDT) are pegged to fiat currencies or assets, requiring equivalent reserves. When users redeem USDt for fiat, tokens are “burned” to maintain a 1:1 peg, meaning those specific tokens are permanently removed from circulation. Conversely, when a new fiat is deposited, an equivalent amount of tokens is minted. This mechanism ensures that the supply of stablecoins always aligns with the underlying reserves, upholding stability and trust in the peg.
Step 2: Identifying tokens to burn
Once the decision is made, the team decides the amount of tokens to remove from circulation. This can be a fixed number or a percentage of the total supply, depending on the goals of the burn.
The blockchain’s smart contract steps in here to check if the requester has enough tokens in their wallet to complete the burn. The system also ensures the specified amount is valid — positive and not zero. The burn won’t go through if they don’t have enough tokens or if the amount is invalid.
Step 3: Sending tokens to burn
When burned, tokens are typically sent to a specific wallet, often called a “burn address” or “eater address.” Tokens in this address are effectively frozen and become permanently inaccessible.
To initiate burning, a project calls a “burn function” on the blockchain. This specific command tells the network to proceed with the burning process. When activating this function, the amount of tokens to be burned is specified.
Step 4: Verifying the burn on the blockchain
The burn process is transparent. Once tokens are sent to the burn address, the transaction is recorded on the blockchain, where anyone can verify it.
Many projects also announce “burn events” to the community, keeping the process open. This visibility helps maintain trust and allows the community to track the burn event on the blockchain, verifying that the tokens are truly out of circulation.
Did you know? “Burn rate” is a metric sometimes used to measure projects’ health. A higher burn rate can indicate that a project is actively reducing supply to increase scarcity, but it could signal an unsustainable economic model if it’s too high.
Why do projects burn tokens?
While it may sound counterintuitive to destroy tokens, there are a few reasons for token burning, each serving a unique purpose to support a project’s growth, security or stability.
While the primary purpose of token burning is often to boost value by reducing supply, the benefits extend far beyond just increasing scarcity.
Improving investor confidence
Regular token burns can also help build trust and confidence in a project’s community. Users who see a company committing to scheduled burns often perceive it as a sign of commitment to stability and long-term growth. Projects can calm investor concerns about inflation or market dilution by showing that the supply will continue to decrease.
Error correction
Sometimes, token burns are a practical solution for accidental token creation or technical errors. For instance, if a bug leads to the unintentional minting of additional tokens, burning the surplus can prevent the unintended tokens from destabilizing the currency.
Stabilizing algorithmic stablecoins
Token burning plays a unique role in algorithmic stablecoins, designed to maintain a stable value, typically pegged to a fiat currency. Stablecoin projects use token burns to remove excess tokens from circulation, keeping the coin’s value balanced at its peg.
For example, the system might mint more tokens if an algorithmic stablecoin’s price rises above its target. If the price falls, tokens are burned as part of a token supply reduction to help bring the value back up.
Enhancing security and reducing spam
Token burns can also help protect a network. For example, some blockchains burn a small amount of tokens from each transaction fee. This discourages spam transactions and protects the network from overloads or distributed denial-of-service (DDoS) attacks. By attaching a cost to every transaction, projects reduce the chances of malicious actors overloading the system for quick profits or to disrupt the network.
Gaining mining rights with proof-of-burn
Some blockchains use a unique approach called proof-of-burn (PoB) as part of their consensus mechanism. Here, miners must burn a portion of their tokens to earn the right to mine new blocks and gain rewards. By sacrificing tokens, miners demonstrate their commitment to the network, which helps maintain security and balances resource use without the high energy costs of proof-of-work (PoW) systems.
Did you know? Certain projects use “community-driven burns,” where the community votes on whether or not to burn tokens, giving tokenholders a direct say in the project’s strategy.
Token burn vs. minting
Minting and burning are two key processes that help manage the supply and value of tokens in a blockchain ecosystem.
Minting is how new tokens are created and added to the blockchain. This happens when tokens are generated for initial sales, as rewards for network participants, such as miners or validators, or for raising funds for development.
Minting ensures there is enough supply to meet demand, especially when the network grows or needs more tokens for various activities.
Burning, on the other hand, is the process of removing tokens from circulation. The goal is to find a balance — minting vs. burning equilibrium — where the right number of tokens is minted to meet demand without overinflating the supply.
At the same time, burning ensures that the supply doesn’t get out of hand, keeping the value stable for users and investors.
In many token economies, minting and burning are interdependent mechanisms. For example, projects might mint tokens to reward users or provide liquidity but burn tokens to reduce inflation and maintain scarcity. Burning can create deflationary pressure, which may increase the token’s value as the supply decreases. This balance is important in projects that want to reward users while making sure the economy stays stable.
Some blockchains also use burning as part of their transaction fees, removing a portion of fees to help control the supply. Together, minting and burning help manage the supply, demand and value of tokens in the system.
