What is Burn Coin? Can Burn Coin Reduce Inflation?

The term “Burn coin” might sound strange to those who aren’t very familiar with the crypto market. So, what does “Burn coin” really mean? Does it have the same literal meaning that might lead people to imagine burning virtual money into ashes in a virtual space?

If you’re curious about “Burn coin” or coin burning, then this article from Forex is definitely for you. Keep reading to understand what burning a coin really means!

1. WHAT IS BURN COIN?

So, what exactly is Burn coin? The concept of burning or destroying cryptocurrencies is relatively accurate in how people think about it.

Burn coin refers to the process of permanently removing a certain amount of coins from circulation, with the goal of reducing the total supply and curbing inflation of that specific cryptocurrency, for various reasons. This process is executed using the Proof of Burn (PoB) consensus algorithm, which TradaFX will explain in more detail in the next section.

A notable example of the Burn coin mechanism that you should know about is Binance Coin (BNB). You may not know this, but BNB originally appeared on the Ethereum blockchain (as BNB ERC-20) before Binance developed its own blockchain, the Binance Chain. After the launch of Binance Chain, the old BNB ERC-20 coins were gradually swapped for the new BNB BEP-2.

Previously, when BNB was still on the Ethereum platform, Binance conducted periodic quarterly coin burn events based on smart contracts with a burn feature. After the Binance Chain mainnet was launched, the burning of 11,654,397 BNB ERC coins was recreated on the new platform to ensure that the total supply of BNB remained unchanged. Instead of burning coins through smart contracts as before, the process was executed through a specific command on the Binance Chain.

Binance’s coin burn events follow a pre-set quarterly schedule, with the goal of destroying 50% of the total BNB supply released into the market, stopping once it reaches 100,000,000 BNB. According to Binance, they had completed 17 coin burn events by October 2021, as follows:

2. ACTIVITIES OF THE PROOF OF BURN (PoB) MECHANISM

Proof of Burn (PoB) is a consensus algorithm based on the mechanism of destroying value to transfer value. For example, if you own 1 BTC and want to develop a new cryptocurrency with a projected circulating supply of 1000 tokens, you can burn 1 BTC to back the value of these 1000 new tokens.

In practice, the process of burn coin is the act of transferring a certain amount of coins into a public “burn” wallet, making the coins permanently inaccessible and considered to be “burned.”

3. WHY SHOULD YOU BURN COIN?

Many people may not understand why they need to burn coins, as it seems similar to destroying an asset you own. However, burning coins actually brings certain benefits for project owners. So, what is the purpose behind coin burning?

3.1 Increase the Value of the Cryptocurrency

If you’re wondering about the benefits of burn coins, the first advantage is the growth in value of the token itself. Simply put, according to the law of supply and demand, the fewer tokens available in circulation, the higher the value of those tokens. This is why most projects have specific plans for the number of tokens they want to issue.

However, this is relative because the market is constantly changing, and burn coin is a method to gradually reduce the amount of cryptocurrency in circulation. As shown in the previous example, Binance executed this through its scheduled coin burn events for BNB, reducing the total supply of BNB on the platform, thereby strengthening the long-term value of the coin and making BNB more attractive to investors.

3.2 Fixing Mistakes

Sometimes, projects encounter errors after being released, and the development team has to correct these issues through the process of burning tokens. For example, the number of coins issued may be problematic due to unforeseen issues, the issuance method may not be suitable for circulation and trading, or there may be technical errors.

3.3 Eliminating Unsold Tokens

Coin projects during the ICO phase usually have plans for the number of coins to be sold within a given time frame. In some cases, there may be a quantity of tokens that has not yet been sold and is still circulating in the market. The project owner can either continue selling these unsold tokens to gain more profit or burn the unsold coins.

In reality, the raised capital will be ensured to be used only for business purposes, as determined by the actual demand for the cryptocurrency of that particular project.

3.4 Adjusting Ownership Shares

As you know, burning coins reduces the total supply, which in turn increases the value of the tokens, making them more attractive to investors in the long term. This is also a way to increase the rewards that shareholders receive by increasing the value of the assets they own, rather than paying them dividends directly.

4. RISKS OF BURNING COINS

So, does burning coins have any risks? With the goals of burning tokens listed above, many investors may think that burning coins is entirely positive since it shows that the project owner is protecting the token’s value and the investors’ long-term interests. However, this is not necessarily the case.

The risk of burning coins may come from the assumption that it is always a positive move. Why? Let’s take Bitcoin as an example. With 21 million tokens in total supply, the belief in the future scarcity of BTC is widely recognized by investors.

They have a basis for their belief that the reduction in total supply leads to an increase in the value of the token. However, the way tokens circulate in practice is difficult to grasp. For example, in some cases, Bitcoin may create new tokens, such as through a fork of the cryptocurrency. This cannot be prevented for Bitcoin or any other project.

In conclusion, investors need to understand that only when the scarcity of tokens is guaranteed will burning coins add value to the token and increase the assets of those holding those tokens. Without this guarantee, the belief in the scarcity of tokens and the increase in token value has little foundation.

5. SUMMARY 

This article by Forex has explained in detail the concept of burning coins, the purpose behind it, and the associated risks of this mechanism. If this article has provided useful information for you, be sure to continue following TradaFX and don’t miss our future posts on related topics in the crypto field!