• Token burning is a process of reducing the total supply of a cryptocurrency, potentially increasing its value.
• It involves sending tokens to an inaccessible wallet—a digital vacuum—permanently removing them from circulation.
• Token burning can be used to manage inflation, incentivize participation in the market, and stabilize prices.
• Prominent cryptocurrencies that engage in token burning include Ethereum, Binance Coin, and Shiba Inu.

Cryptocurrencies are digital assets with native chains. Tokens run on parent protocols. In this text, we use them interchangeably for easier reader experience. Both assets can be burned. More basic terms here.

What is Token Burning?

Token burning is a process in which cryptocurrency tokens are intentionally removed from circulation by sending them to an unusable wallet address, often called a "burn address." This reduces the total supply of the tokens, which results in a kind of economic deflation and increases scarcity. If the demand is constant before and after the burning event, the price of the remaining tokens will theoretically increase.

This mechanism is used by various cryptocurrency projects to manage inflation, control supply, and incentivize long-term holding.

How Does Token Burning Work?

Token burning involves sending tokens to a burn address. This address is the address of a wallet with no known private key, meaning that once tokens are sent there, they are permanently irretrievable. The process is usually (and should be) transparent and verifiable through blockchain explorers. This ensures that the community can see the exact number of tokens burned. 

To prevent speculation and distrust, some projects automate this process via smart contracts, safeguarding that a predetermined number of tokens are burned at regular intervals or upon certain conditions being met. For example, Ethereum introduced a fee-burning mechanism with its London upgrade (EIP-1559), where a portion of the transaction fees is burned, reducing the supply of ETH over time. Of course, Ethereum has no final total supply as Bitcoin does, so the supply at the same time grows continuously.

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Process of Token Burning:

1. Initiation of a Burn Transaction: Predictably, it all begins when a token holder or the issuing project decides to burn tokens. This decision can be motivated by various factors, such as reducing supply, increasing scarcity, or achieving specific project goals.
2. Specification of Tokens to be Burned: The initiating party determines and specifies the number of tokens to be destroyed. This determination is done through a mathematical equation via a function in the token's smart contract, which facilitates the process.
3. Sending Tokens to a Burn Address: The stated tokens are sent to a designated burn address which renders it inaccessible. Commonly used burn addresses include the null address (0x0000000000000000000000000000000000000000) or a similarly configured address designed to be unspendable.
4. Blockchain Recording and Transparency: The burn transaction is recorded on the blockchain making it transparent and verifiable by anyone. This is extremely important because it builds trust within the community and confirms the authenticity of the burn.
5. Smart Contract Automation (Optional): In many cases, smart contracts automate the token-burning process. These contracts are programmed to trigger token burns based on predefined conditions. Conditions might stem from transaction fees, periodic schedules, or specific events. This automation is vital to ensure consistency and remove the need for manual intervention.
6. Updating the Total Supply: After the burn transaction is executed, the total supply of the cryptocurrency is updated to reflect the reduced number of tokens. This update is automatically managed by the blockchain network and is reflected in the blockchain's public ledger.
7. Security and Verification: The burn address and the burned tokens are permanently locked away, so they can never be retrieved or used again. Blockchain explorers and auditing tools can verify this, presenting another layer of security and transparency.
8. Periodic Reporting and Community Engagement: The last step is simply to report the burn event to the community. Not only is it transparent, but it also fosters trust. Regular updates on burn actions help maintain investor confidence and demonstrate the project's commitment to its economic model.

Economic Impact of Token Burning

Deflationary vs. Inflationary Effects of Token Burning

While token burning is often described as deflationary, it’s important to discuss how it contrasts with inflationary mechanisms. Token burning reduces supply, increasing scarcity and potentially driving up value, while inflationary mechanisms increase supply, which can dilute value if not managed properly. Inflationary measures are usually used to encourage participation, when tokens are functioning as a reward of sorts. 

Impact on Token Economics

Token burning affects various stakeholders differently, including short-term vs. long-term holders. The psychological impact on market behavior can be significant, as consistent burning might increase investor confidence and stimulate long-term holding.

Transaction Fees

Every blockchain interaction is a transaction. Burn transactions incur costs, just like any other transaction. This isn't a problem if a project burns tokens once a quarter, but it can be a major issue if the project intends to burn tokens for every transaction fee paid.

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Alternative Mechanisms to Token Burning

There are some alternatives to token burning that might prove useful for managing the supply of said assets. Each has its advantages and disadvantages, and projects must choose the best approach for their specific goals.

• Buybacks: The project repurchases its tokens from the open market to reduce the circulating supply, theoretically increasing their value.
• Minting Policies: There can be a wide-ranging set of policies, usually designed to encourage participation. One example might be the slow minting of new tokens as a reward for stakeholders. Manipulating the amount of such minted tokens can then function as an alternative to burning.

What are the Effects and Use-Cases of Token Burning?

The effects of token burning on a cryptocurrency's ecosystem can be various:

• Scarcity and Value Increase: As previously discussed, reducing the number of tokens in circulation increases the scarcity of the remaining tokens, which has the potential to increase token value. Token burning is attractive to investors looking for long-term appreciation.
• Market Stability: Reducing the supply of tokens can help stabilize the market by curbing excessive inflation and preventing large-scale price fluctuations.
• Incentivizing Participation: Some projects use token burning as a way to incentivize participation in their ecosystem. For instance, in Proof-of-Burn (PoB) mechanisms, participants burn tokens to gain the right to mine new blocks or validate transactions, similar to staking in Proof-of-Stake (PoS) systems.
• Trust and Confidence: Consistent and transparent token burns can build trust within the community. When a project demonstrates its commitment to controlling supply and supporting token value, it can enhance its credibility and attract more users and investors.
• Marketing and Publicity: Token burns can generate publicity and draw attention to a project. Announcements of significant token burns easily create buzz and attract new investors and traders.

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Use Cases of Token Burning

Many projects employ token burning for different purposes. Binance Coin (BNB) burns tokens quarterly based on trading volume to reduce supply. Shiba Inu (SHIB) uses a burn mechanism to increase token scarcity and value over time. Stablecoins like USDC and USDT are occasionally burned by their parent organizations to help maintain their peg to fiat currencies.

Below, you can find a few specific examples of how token burning works in different projects.

Use Cases:

• Binance Coin (BNB): Conducts quarterly burns based on trading volume.
• Shiba Inu (SHIB): Uses a community-driven burn mechanism to increase token scarcity.
• Ethereum (ETH): Introduced in the London upgrade (EIP-1559), this protocol burns a portion of transaction fees with every transaction.
• Ripple (XRP): Uses an escrow mechanism to release and burn tokens periodically.
• Tron (TRX): Conducts regular burns from transaction fees on the network.
• Huobi Token (HT): Operates a buyback and burn program using a portion of quarterly revenue.
• VeChain (VET): Burns tokens as part of its Economic Node program to reduce supply and enhance value.

Potential Risks and Downsides

Market Manipulation

Risks like market manipulation are present. Large-scale burns by a few holders could significantly influence the market. Every project interested in token burning should make sure that they are transparent and fair to all stakeholders.

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Sustainability

Consider the sustainability of continuous burning practices. Projects must evaluate the long-term viability and potential drawbacks of ongoing token burns.

Which Projects Burn Tokens and Their Burn Rates

• Ethereum (ETH): Burns a portion of transaction fees. Each year, an average of 303,000 ETH tokens are burned, while 918,000 are newly issued.
• Binance Coin (BNB): Quarterly burns based on trading volume. The burn rate varies greatly. In Q1 of 2024, BNB worth $1.17B was burned.
• Shiba Inu (SHIB): Regular community-driven burns. In 2024, 41 % of the total supply was burned. The burn rate varies greatly, sometimes even increasing by 140,000%.
• Ripple (XRP): Periodic burns from escrow releases. In 2024, the burn rate shot up by 101%. 636,184 XRP was burned worth around $360,000.
• Tron (TRX): Regular burns from transaction fees. The system overall is really complex. In 2024, around 1.3 billion of TRX were burned.
• Huobi Token (HT): Buyback and burn program: First, they repurchase HT from the market, then burn them to decrease the total number of tokens. This occurs on a monthly basis. In 2024, Huobi advisor Justin Sun burned a whopping 20 million tokens.
• VeChain (VTHO, VET): VET is the native coin, while VTHO functions as gas for transactions. With VTHO, an economic node program burns 70% of all transaction fees to control inflation, with the remaining 30% going to validators. VET is not burned per se, but buybacks happen regularly by the organization behind VeChain, either to stimulate the coin's value or to celebrate important milestones. There is one special case, though: In 2020, 727 million stolen VET, gained through hacking, were burned.
• MakerDAO (DAI, MKR): The project involves a complex process of buybacks, burns, and supply management for both cryptocurrencies. Tokens DAI are burned when closing collateralized debt positions.
• Bitcoin Cash (BCH): The project burns tokens to manage supply. Running on a PoW consensus, validator Antpool decided to burn 12% of all coins earned through mining. A sharp price increase followed.
• Stellar (XLM): Only one burn was concluded in 2019 when the project burned 50% of the supply.
• ApeCoin (APE): Burns tokens from marketplace fees in an attempt to stabilize price after the NFT market crash.
• XEN (XEN): To manage supply, the project engages in significant token burns. Projects running on the X1 protocol also participate by burning tokens.
• Terra Classic (LUNC): Terra conducted major burns to control supply. In 2023, an exceptional hack essentially reduced the price to zero, forcing Terra to create a different protocol, Terra 2.0, with a new native token, LUNA. Now, large burns of LUNC are being conducted in an effort to help it regain value. A total of 129 billion LUNC has been burned.
• Crypto.com (CRO): The project has long struggled with inflation, leading to a proposal for token burning. In 2024, 70 billion CRO tokens were burned. The company behind the exchange regularly releases data about the burning process.

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