Why Burn Crypto?
Blockchain projects and communities can engage in crypto burning in various situations. Here are some examples:
Proof of Burn
Some cryptocurrencies rely on burning at the infrastructure level. They employ the so-called Proof of Burn (PoB) consensus mechanism, which requires nodes to burn a portion of their holdings to become eligible to validate new blocks.
PoB combines elements from Proof of Work (PoW) and Proof of Stake (PoS), and is regarded as an experimental algorithm to achieve energy efficiency. Some examples of cryptocurrencies using PoB are Namecoin and Slimcoin.
The PoB mechanism comes in various versions:
- In a PoB-based chain, miners have to burn the native coin to add new blocks. Eventually, the losses are offset by rewards.
- Some networks require the burning of a cryptocurrency different than the native one, e.g., Bitcoin (BTC).
- There are more complex PoB mechanisms in which miners burn native coins in exchange for credits that can eventually be used to perform certain functions on the network.
In this context, burning is not necessarily used as a deflationary mechanism, and it doesn’t affect the supply.
Stablecoins, Synthetic Assets, and Wrapped Tokens
Burning is a key mechanism used by most stablecoins, wrapped tokens, and synthetic assets (synths). All of these are blockchain-based tokens backed by underlying assets. For example, stablecoins like USDT and USDC are predominantly backed by fiat currencies;wrapped tokens like wrapped eth are backed by other cryptocurrencies, and synths mirror the price of real-world assets like stocks or commodities.
These tokens try to maintain parity with the underlying assets by balancing against reserve assets held in custody. This balance is maintained by minting new tokens or burning them based on the supply of reserve assets.
When people sell these tokens to redeem the underlying assets, the tokens are automatically burned.
Support Token Value in the Long Term
Certain volatile cryptocurrencies and tokens undergo the burning of a portion of their supply to help stabilize their price in terms of USD. These burns can take the form of either one-time processes or recurring events that are programmed from the outset.
This deflationary strategy is meant to reduce the supply or the inflation rate, thereby improving investor confidence.
Some crypto projects buy back crypto from the open market and burn it to support the price, similar to stock buybacks. For example, Binance uses a portion of its profits to buy back and burn Binance Coin (BNB). Thanks to these regular buybacks, BNB’s supply is gradually declining, supporting the price in the long term.