Cryptocurrencies differ in many ways from fiat money. Among the differences are the features of the issue. Fiat money is issued by central banks or other authorities in consultation with governments. They decide on the issue, its volumes. At the same time, fiat money is not backed by anything, so the emission leads to inflation.
The emission of cryptocurrencies can be limited, as in the Bitcoin network and other coins, or unlimited, as in Ethereum. Digital assets have a different pricing principle. Their cost depends on the news background, statements by various figures, economic or political crises, and so on. At the same time, additional emission causes inflation, the exchange rate falls. To avoid this phenomenon, developers make various decisions, including the burning of coins.
What is burning process
This is the withdrawal of coins from circulation. Basically, it’s just sending coins to an address for which there are no access keys. Cryptocurrency burning can be done in different ways, including manually.
It should be noted that the withdrawal of the volume of the cryptocurrency from the turnover does not always lead to an increase in the value of the asset. If the project is little known, not in demand, its rate is low. You can burn all the coins, the price will not rise. In other words, withdrawal from circulation works in popular projects.
Why does the system need such a process?
The main purpose of burning is to fight inflation, increase the asset’s rate by reducing the volume. An analogy can be drawn with gold and other precious metals. The limited volume provides high cost.
By burning coins, the project developers raise the rate. At the same time, the benefits are obtained in the short and long term. Instantaneous price increases grab the attention of investors who buy the growing asset, further pushing up the value.
In addition to increasing the exchange rate, the withdrawal of assets has a positive effect on the stability of the project. It is possible to maintain the capitalization of the cryptocurrency at a high level. The frequency and volume of burning depend on the rate of issue of new coins, the number of asset holders.
After the initial coin offering (ICO), the project developers burn the remaining tokens. This increases the value of the assets received by the investors during the process.
The most famous incineration incident, not related to the developers, happened with Vitalik Buterin. He received 250 trillion coins from the creator of the Shiba Inu cryptocurrency, which was about half of all issued assets. The cost of the coins at the exchange rate at the time of the transfer of the equivalent of $13 billion.
Buterin burned almost all the coins transferred to him and transferred the rest to the Indian Fund to Fight Coronavirus. According to Buterin, he made a withdrawal from circulation to maintain the cryptocurrency rate, which could fall due to such a large movement of assets. At the same time, there are rumors about Vitalik’s involvement in the development of Shiba Inu, then his actions are just a publicity stunt.
The most popular algorithms for confirming transactions are Proof-of-Stake and Proof-of-Work. There are other ways, including Proof-of-Burn. The proof-of-burn mechanism is not in great demand; it is used in the Counterparty cryptocurrency and some others.
The basic principle of PoB is that a miner must burn coins in order to be eligible to create assets. At the same time, you can burn the assets of your project or someone else’s, most often bitcoin. The choice depends on the specific project.
Withdrawal from circulation can be done in 2 ways:
Different protocols assume an output function. At the same time, smart contracts are used that will send the number of coins specified by the user to inaccessible addresses. The Binance exchange practices a quarterly burning of its exchange token Binance Coin (BNB).
The Ethereum network uses the burning of miners’ fees. This is a way to reduce asset inflation. The innovation appeared after the EIP 1559 update during the London hard fork. The update made Ethereum more popular by lowering transaction fees. In addition, the price of the asset has gone up, so the method works. During the existence of the burning function in the Ethereum network, more coins were withdrawn than new ones were mined. There is a real decline in the number of assets.