Coin burning refers to the permanent removal of a certain amount of cryptocurrency from circulation. It is an unusual monetary policy tool that is almost exclusive to the world of digital assets and cryptocurrencies.

The act of burning coins aims to reduce the total supply of the cryptocurrency, thereby potentially increasing the scarcity and value of the remaining coins in circulation. Proponents argue that burning supply could lead to price appreciation if demand stays the same or increases.

What is Coin Burning in Cryptocurrency?

Coin burning means the permanent destruction of a certain portion of cryptocurrency coins by sending them to a verifiably unspendable wallet address from which they cannot be recovered. This effectively removes the coins from circulation permanently.

Burning coins reduces the total supply of the cryptocurrency. Since cryptocurrencies have a fixed maximum supply, burning coins means that the maximum is reduced and can never be achieved now. The act of burning coins is recorded on the blockchain for all to verify.

Some key points about what coin burning entails:

• Irreversibly destroys a number of digital currency tokens
• The process is publicly recorded on the blockchain
• Reduces the total and circulating supply permanently
• Coins sent to ‘eater addresses’ that have no private keys
• Nobody can ever access or spend the burned coins again

How Coin Burning Works

Technically, coin burning simply involves sending a certain amount of coins to a ‘burn address’, also known as an ‘eater address’. This is a wallet address that no one has the private keys to access. Thus, the coins sent to that address are provably destroyed and can never be retrieved.

The act of transferring coins to an inaccessible address is recorded on the blockchain, allowing anyone to verify the burn. Since the blockchain acts as a permanent ledger, this provides transparency and ensures that the coins cannot be recovered.

Some technical points on how coin burning works:

• Coins destroyed by sending to ‘eater address’
• These addresses have no associated private keys
• Recorded on blockchain as a typical send transaction
• Coins provably non-recoverable and unusable
• Reduces total supply as recorded on blockchain
• Anyone can verify burns via block explorers

Differences From Traditional Money Burning

In the traditional fiat money system, burning banknotes or coins removes them from circulation. However, a central bank or government can always print or mint new money later on. This contrasts with cryptocurrency coin burning because it permanently destroys coins with no ability to recreate them.

Some key differences between crypto coin burning versus traditional money burning:

• Cryptocurrencies have fixed maximum supplies
• Burning coins reduces maximum forever
• No central party can recreate burned crypto
• Fiat money can be printed again after burning
• Fed can implement monetary policy like QE
• Cryptocurrency network rules prevent reissuing burned coins
• Burning banknotes doesn’t affect fiat monetary policy tools

So in short, coin burning has a very different impact because cryptocurrency supplies are fundamentally fixed. Burning permanently reduces the total supply according to protocol rules.

The Rationale Behind Coin Burning

There are several reasons why a cryptocurrency project may choose to burn coins. These include increasing scarcity, signaling commitment, maintaining fixed inflation rate, and generating profits for the burning entity.

Increasing Scarcity to Appreciate Value

The most common reason to burn coins is to artificially increase the scarcity of the cryptocurrency. This follows the typical supply and demand theory.

By permanently removing coins from circulation, the total supply reduces. If demand remains the same or increases in the future, basic economics suggests that decreasing supply should translate to higher prices. By appreciating value, holders benefit from their coins gaining purchasing power.

Some points on burning to increase scarcity:

• Reduce total and circulating supply via burning
• Scarcity increased with lower supply if demand steady
• Follows basic supply-demand economic theory
• Could translate to higher valuation if successful
• Holders benefit from appreciation in value

So burning aims to reduce sell pressure and artificially engineer digital scarcity. This seeks to benefit holders via price appreciation.

Demonstrating Long-Term Commitment

Burning can represent a strong long-term confidence and commitment to a cryptocurrency from its founders and community.

Burning large amounts of coins requires faith that the price will be higher in the future to offset the short-term loss. Projects willing to provably burn coins signals incentive alignment and belief in future growth.

Some points on how burning signals commitment:

• Burning large amounts shows confidence in future growth
• Founders incur short-term costs for long-term benefit
• Aligns incentives between project and coin holders
• Builds trust that founders won’t dump on holders
• Shows founders not focused on short-term profits

This signaling effect can bolster community trust in the cryptocurrency and its founders.

Maintaining a Fixed Inflation Rate

Some cryptocurrencies aim to maintain a fixed rate of annual inflation by burning a certain percentage of coins every year. This helps preserve the original monetary policy and tokenomics of the project.

Examples of how scheduled burning maintains fixed inflation:

• Say 5% annual coin supply increase via inflation
• Burn 5% of coins each year
• Net inflation remains same at 5% annually
• Maintains original monetary policy and incentives

Regular scheduled burns to offset inflation prevents dilution of holdings over time.

Generating Profits for Burning Entities

Some projects give mining fees or portions of taxes to select parties who burn them. This incentivizes the entities to burn coins, profiting from appreciation while reducing supply.

Examples of generating profits from burning:

• Block rewards or fees collected then burned
• Burning entity profits if price increases
• Rewards entities helping project via burning
• Allows profit even if burning coins at current price

In essence, they are trading coins at present value for future anticipated gains from appreciation.

Potential Benefits of Coin Burning

There are some theoretically plausible benefits associated with cryptocurrency coin burning, assuming it achieves its aims. Let’s explore some of these potential pros.

Increasing Scarcity and Value

The main goal of burning coins is to increase scarcity and in turn drive appreciation in the cryptocurrency’s value. By reducing supply, economic theory suggests prices should rise all else being equal.

Some potential benefits of increased scarcity and value from burning:

• May increase coin price if successful
• Higher price benefits investors and token holders
• Enhances attractiveness as investment asset
• Improves perception and narrative around project

There are many examples of price surging after burns (which will be covered later). However, causation is difficult to prove definitively.

Stabilizing and Appreciating Prices

In addition to potentially increasing value, coin burning might also stabilize and support prices during market downturns.

With lower circulating supply, large sell-offs may have less impression on price. By limiting downside volatility, burns could aid holder confidence.

How burning might support prices:

• Constrains panic selling impact on price
• Burning reduces available coins to be sold
• Scarcity makes holders less willing to sell
• Supply ceiling removed so sell pressure reduced
• Could limit downside volatility in bear markets

This depends on scale of burning versus market conditions, but it is feasible.

Signaling Confidence and Commitment

As discussed earlier, burning can signal strong confidence in the cryptocurrency from its founders. This builds trust and aligns incentives between leadership and holders.

Further benefits of signaling commitment via burning:

• Shows founders have long-term mindset
• Helps attract buy-in from new investors
• Builds loyalty among existing community
• Narrows gap between holders and core team

Signals of commitment and skin in the game resonate positively with users.

Maintaining Fair Distribution and Inflation

For cryptos with periodic burns to offset inflation, this maintains the intended fairness and distribution. Holders do not suffer from dilution over time, preserving the initial tokenomics.

Benefits of maintaining planned distribution:

• Limits inflationary effects on holders
• Upholds announced monetary policies
• No dilution means holders keep fair share
• Maintains intended tokenomics model
• Contributes to predictability and stability

This is crucial for maximizing trust and transparency for project communities over the long-term.

Risks and Criticisms Associated With Coin Burning

Despite the potential benefits, there are also several risks and criticisms to consider regarding coin burning mechanisms.

Manipulating Prices and Valuations

A common critique of burning is that it allows manipulation of coin prices and market valuations. Since burns directly impact supply, this could enable artificial inflation of prices.

Key risks around manipulation of price and valuations:

• Reducing supply does not always impact demand
• If demand is not organic, prices may be artificial
• Could enable small holders to manipulate price
• Blurs line between speculation and utility value
• Harder to model fair fundamental value

The more burning relies solely on reducing supply, the more it risks being a pure price manipulation tool.

Concentrating Holdings and Supply

Although burning coins removes them from circulation entirely, cryptocurrencies generally start with an uneven initial distribution. For example, founders and early investors get a large portion of initial supply.

This means if these key entities conduct most of the burning, it further concentrates overall holdings and supply in their hands even more.

Risks around concentrating supply:

• Burning often done by founders with large allocations
• Can significantly grow their share of total supply
• Concerning if centralization and control already issues
• Further entrenches their power over project
• Raises questions around decentralization

This issue is most prominent for already centralized or insider-dominated projects.

Reducing Network Security Incentives

Some burns take coins that would otherwise go to staking rewards or mining fees. This could disincentivize securing the network, leading to reduced resilience.

How burning could impact network security incentives:

• Burns may take coins from mining rewards
• Lower rewards reduce incentive to mine or validate
• Could open attack vectors if network less robust
• Creates debate around optimizing fees versus burns
• Security should remain priority over deflation

Thus, projects need to ensure burning does not compromise the cryptoeconomics underpinning their blockchain.

Not Guaranteeing Increased Value

Finally, a major critique is burning does not guarantee increased value. The supply reduction could simply be overwhelmed by larger shifts in demand and market conditions in the cryptocurrency space.

Reasons burning may not impact value:

• Reduced supply does not force demand up
• Demand drives prices more than scarcity alone
• Other factors like adoption and utility matter more
• Macro conditions in crypto influence prices
• Difficult to isolate and measure effect of burning
• Lag between burning and potential price reaction

Many projects have burned tokens without seeing meaningful lasting price increases. So the impact is not assured.

Examples of Coins That Burn Tokens

To provide concrete examples, let’s look at some major cryptocurrencies that have implemented coin burning mechanisms previously:

Binance Coin (BNB)

Binance conducts quarterly BNB burns based on trading volume on their exchange. They have burned over 13 million BNB so far, worth billions of dollars.

Some key points on BNB coin burning:

• Launched in 2017 as native token of Binance exchange
• BNB fees collected by exchange then burned each quarter
• Burning tied to exchange usage and volumes
• Over $1.5 billion worth of BNB burned so far
• Reduces maximum supply from 200 million BNB

Burning is credited for BNB’s strong appreciation versus Bitcoin since launch.

Ethereum (ETH)

The Ethereum network burns a portion of transaction fees via its EIP-1559 upgrade since August 2021. Over 3 million ETH has been burned, worth billions of dollars.

Background on ETH fee burning:

• EIP-1559 released in August 2021 as network upgrade
• Part of transaction fees now burned instead of paid to miners
• Reduces ETH issuance and offsets inflation
• Over 3 million ETH burned worth billions so far
• Significantly reduces circulating supply growth

This burn mechanism is a key part of Ethereum’s transition to a deflationary monetary policy.

Cardano (ADA)

The Cardano network burns a portion of transaction fees via its treasury system. The burned ADA is removed from the circulating supply.

Details on ADA coin burning:

• Cardano uses Ouroboros Proof of Stake consensus
• Transaction fees split between staking rewards and treasury
• Treasury ADA is burned once used or after several years
• Burning reduces total and circulating supply
• Smaller impact so far but contributes to deflation

This mechanism ensures fees are not just recycled into circulation.

KuCoin Token (KCS)

The KuCoin exchange implements quarterly burns of KCS based on trading volumes on the platform. Over 22 million KCS has been burned since start.

Overview of KCS burns:

• KCS is native exchange token of KuCoin exchange
• Launched in 2017 as incentive for exchange users
• Burning done quarterly based on exchange volumes
• Burns offset inflation and total supply expansion
• Over 20% of supply burned historically

The burns have covered the staking rewards paid, effectively maintaining a fixed supply.

Uniswap (UNI)

Uniswap distributed 1 billion UNI via airdrops in 2020. In 2021, they implemented a burning program funded by a portion of protocol fees.

Details on Uniswap’s UNI burning:

• UNI is the governance token of the Uniswap DEX
• Launched via airdrops in September 2020 -fee switch implemented in May 2021
• Portion of 0.05% protocol fees burned
• Started with retroactive burning of 7.1 million UNI
• Ongoing burns reduced supply by over 10%

The UNI burns are voted upon by governance, aligning with its decentralized ethos.

The Mechanics of Coin Burning

Now that we have covered examples, let’s take a technical look under the hood at how coin burning works. This covers the blockchain mechanics and logistics involved.

How Burning Is Implemented

As described earlier, coin burning from a technical perspective simply means sending coins to an address that is provably unspendable. This renders the coins permanently irretrievable.
On most blockchains, these burn addresses have a clear identifiable pattern.

For example, on Ethereum the burn address is ‘0x000000000000000000000000000000000000dEaD’.

No one controls or stores private keys associated with these addresses. The patterns also mark them clearly as burn addresses rather than normal wallet addresses.

When coins are sent to irretrievable addresses, they still continue to exist on the blockchain itself. Everyone can verify on chain that the coins were burned and take them into account for supply calculations. But no one can move or unlock those coins again.

Difference Between Burning and Minting

Burning coins is the opposite of minting new coins. Minting refers to the creation and distribution of new coins on a blockchain according to a set inflation schedule and mechanism.

Burning reduces total supply, while minting increases it. Burning also destroys specific coins that already existed, while minting generates entirely new coins.

In this way, burning and minting form two sides of managing the total supply - contraction versus expansion.

On-Chain Versus Off-Chain Burning

Some burns happen directly on-chain, recorded permanently via transactions explicitly sending coins to irretrievable addresses. This is the most transparent and verifiable mechanism.

Other methods may simply involve taking coins out of recorded circulation off-chain while keeping supply unaffected on-chain. This means the circulating supply is reduced via accounting, but the total supply remains unchanged.

On-chain burning permanently reduces total supply via the blockchain itself. Off-chain burning just affects the circulating supply metric.

Frequency and Amounts Burned

Burning mechanisms can vary widely in terms of schedule and quantity burned:

• Schedule can be predictable like quarterly or happen sporadically
• May burn fixed amount, fixed percentage of supply, or variable amount
• Schedule and amounts are configurable parameters
• Some base burning on usage like transaction fees generated
• Others rely on fixed schedules for consistency

There is no standard framework, allowing projects flexibility to design burns tailored to their goals and characteristics.

Relationship With Total Coin Supply

Burning coins essentially cancels out coins previously created and added to total supply. The amount burned is subtracted from total and maximum supply.

Since most cryptocurrencies have a finite capped supply, burns make it so that cap can never actually be reached anymore. Future supply growth is permanently dampened by the contraction.

Over time, the gap between total supply cap and actual supply widens. Ultimately, the network ends up with a lower maximum than originally specified.

The Effects of Coin Burning on Supply and Circulation

Now that we have covered the mechanics of burning, let’s examine its mathematical impact on cryptocurrency supplies and how this plays out over time.

Reduced Current and Future Supply

Every single coin burn has the effect of decreasing both the current total supply of coins as well as the maximum possible future supply. No burned coins can ever be restored or recreated.

Some ways burning decreases supplies:

• Reduces total supply by amount burned
• Also reduces maximum possible future supply
• Less supply created in future due to burn
• Permanently decreases both current and potential supply

This makes the cryptocurrency more scarce relative to its original design.

Impacts on Circulating Supply Metrics

Burning reduces the total supply which is the main cap that matters long term. But in the shorter term, burns also decrease the circulating supply.

Some ways this impacts circulating supply:

• Lowers outstanding supply in exchanges and wallets
• Reduces amount readily available for trading
• Decreases liquid coins that can affect price action
• Leads to lower market capitalization valuations

This contracting effect on the circulating supply makes the cryptocurrency more scarce in the active marketplace. All else being equal, decreased circulating supply typically leads to upward price pressure.

Burning Supply Held by Founding Teams

In many cases, most of the coin burning comes from large allocations held by founding teams and early investors. This makes sense since they hold the majority of supply.

Consequences of this phenomenon:

• Founders often burn their heavy personal allocations
• Further concentrates overall supply in their hands
• Critics argue this entrenches insider power
• Contributes to centralization over time
• Means impact muted if founders still retain substantial portions

This dynamic is worth considering regarding decentralization and distributions.

Deflationary Effects Over Time

With frequent ongoing coin burning, the cryptocurrency transitions to a deflationary monetary policy over time provided demand remains reasonably steady.

Deflationary implications:

• Sufficient burning can surpass new issuance
• Eventually leads to net reduction in total supply
• Deflationary if outpacing minting activities
• Increases scarcity predictably over time
• Contrasts with inflationary policies of printing fiat

This deflationary mechanism is groundbreaking in modern monetary systems.

The Impact of Burning on Cryptocurrency Prices

Now that we have covered the supply implications, let’s examine the possible effects of coin burning on cryptocurrency valuations and prices. This relationship is complex.

Correlations With Increased Prices

There are certainly many examples of prices pumping upwards immediately following burn announcements. This demonstrates a psychological impact. Traders anticipate less supply leading to upwards price pressure.

Some evidence of burning impacting prices:

• Prices often surge around burn events
• Shows anticipation of reduced sell pressure
• Follows standard supply and demand curve logic
• Burn announcements are catalysts for momentum
• Implies strong speculative interest and incentives

However, long-term causation is difficult to confirm definitively.

Other Factors That Affect Prices

While burning seeks to directly influence price via supply, many other factors unrelated to burning also drive crypto valuations. These can easily outweigh or nullify the effects of coin burning.

Some external factors also driving prices:

• Broader market sentiment and conditions
• Macroeconomic environment
• Adoption and utility of the cryptocurrency
• Perception, hype cycles and narratives
• Monetary policy affecting fiat currencies
• Competition from other crypto assets

So supply is just one variable among many affecting prices.

Critiques of Burning Impact Claims

Given the above, many analysts critique claims that burning mechanisms directly lead to substantial price increases over the long run. Correlation does not necessarily equal causation.

Reasons burning may not actually impact prices:

• Just one factor among many affecting valuations
• No guarantee of increased demand due to burn
• Traders can still overwhelm supply effects
• May require accompaniment of other catalysts
• Lag between burn and potential impact varies
• Hard to isolate direct effect quantitatively

Burning leading to consistent rises across crypto markets is debated.

Comparisons to Stock Buybacks

Some compare coin burning to public companies buying back stock to reduce share supply. This aims to boost earnings per share and valuations.

But key differences exist:

• Share buybacks don’t affect total shares authorized
• Company can always issue new shares later
• Cryptocurrency burning reduces maximum forever
• Companies must have excess cash to fund buybacks
• Crypto projects burn tokens out of circulation

The permanent supply reduction makes coin burning a very different mechanism.

The Future of Coin Burning in Cryptocurrencies

Given the myriad of approaches so far, let’s now look at where coin burning in crypto may be headed in the future.

Predictions for Greater Adoption of Burning

Based on industry trends, experts predict significantly more projects will incorporate coin burning mechanisms going forward.

Reasons for wider adoption:

• Aligns with shift toward deflationary tokenomics
• Crypto community receptive to lower supply
• Helps projects stand out in crowded field
• Easy to implement technically
• Flexible parameters to tune as desired

Burning aligns neatly with the cryptocurrency ethos of provable transparency and auditability.

Use Cases Going Forward

Some projections on optimal and novel use cases for burning coins as adoption increases:

• Deflationary mechanisms for stablecoins
• Driving up virtual land and metaverse valuations
• Governance capabilities via burning votes
• Initial supply distributions done via burns
• Burning to reward verifiable green mining

The flexibility of programmatic money allows room for experimentation.

Questions and Risks Around Burning Coins

Despite the benefits, questions and uncertainty remain around burning models:

• How to determine optimal burn amounts and schedule?
• Avoid overengineering and unwarranted complexity
• Ensure burning aligns with concrete goals
• Prevent centralization of supply in core team over time
• Should burning have on-chain governance?
• Do benefits outweigh potential risks?

Projects need to thoroughly analyze pros and cons of implementing burns.

Alternatives to Supply Reductions

Burning is not the only way to achieve benefits like stabilizing prices and incentivizing holders.

Other alternatives might include:

• Directly expanding utility and adoption long-term
• Enabling greater access and distribution of supply
• Limiting whale concentrations via caps
• Smart staking rewards and lockups
• Treasuries and buybacks to support prices
• Governance votes guiding minting and burning

Combined approaches can optimize for sustainability.

Conclusion

In summary, coin burning is an intriguing monetary policy tool used by cryptocurrency projects to provably reduce total supply. By destroying a portion of coins permanently, it aims to increase scarcity and therefore value of the remaining supply based on economic principles. Proponents argue the decreased circulating supply will lead to upwards price pressure and stability, while also signaling confidence in the project’s future appreciation. It aligns with the shift towards deflationary tokenomics. Coin burning is likely to grow in adoption as projects compete on tokenomics creativity and committing to deflation. But its parameters and trade-offs will require careful consideration to balance benefits versus potential downsides.

However, burning also carries risks like enabling price manipulation, concentrating supply, and reducing network security incentives. Its impact on actual cryptocurrency valuations is also debated, given the multitude of factors affecting prices.

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