The increasing popularity of cryptocurrencies has given rise to many new crypto coins, creating stiff competition in the crypto market. To increase the demand for crypto tokens developers adopt different strategies, the fundamental being the fixed supply of tokens, fostering an increase in demand.
Apart from the fixed supply, a burning mechanism is also deployed by developers to create a scarcity of tokens and thereby increase demand and value. In this article, we explain the burning mechanism in crypto and its impact on investors.
What is Burning Crypto?
Burning crypto is a strategy deployed by crypto developers to increase the demand for crypto tokens. Cryptocurrency burning refers to the removal of a certain number of crypto tokens from circulation by sending them to an inaccessible wallet address. The burning results in a scarcity of tokens, creating a demand.
The Major Reasons for Burning Crypto
1. Increasing the demand
The prime and fundamental reason for burning a cryptocurrency is to increase its demand. When certain cryptocurrencies are burnt, their circulation in the market reduces which inflates scarcity. This in turn creates a demand for the token resulting in an increase in price.
2. Preventing high volatility in price
Cryptocurrencies offer prices similar to their underlying assets, like the US dollar or other fiat currencies. The burning mechanism allows the token to remain at a stable and consistent price without being much affected by the volatile market.
3. Safeguarding the blockchain network
Crypto burns protect blockchain networks from Distributed Denial of Service (DDoS) attacks.
In this type of attack, a large number of requests are sent to the blockchain network by using the bots, resulting in congestion or overload. The burning mechanism makes DDoS attacks less feasible since the number of coins circulated is under control.
4. Enhancing long-term investments
Burning of tokens creates deflationary status, creating positive market sentiments in the crypto community. This encourages investors to hold the currency for the long term, increasing the value of the cryptocurrency.
How Does a Crypto Burning Work?
Crypto burning utilizes smart contracts to enable burning. The holder mentions the amount of crypto tokens that are required to be burned. The tokens’s smart contract verifies whether there are enough tokens available for burning.
If there are not enough tokens available on the wallet address for burning the crypto tokens, it is considered invalid and prevents the initiation of the transaction. If the wallet address has enough tokens, the smart contracts automate the transaction, transferring it to the invalid wallet address. The transfer completes the burning process.
Importance of Proof of Burning (PoB)
Proof of Burning is a consensus mechanism that encourages investors to burn crypto tokens. By sending the tokens to an invalid address, the investor takes part in a burning mechanism, helping them to validate a transaction and secure the network. The addresses to which the tokens are sent are invalid, which means the tokens sent can’t be transferred back or recovered.
The holder who removes the token from circulation by burning is given the right to validate the transaction based on the number of tokens they burned. Burning a large number of tokens increases the amount of rewards received.
How Does Token Burn Impact Investors?
- Token burning removes a certain number of tokens from circulating in the market. The reduction in number of tokens creates a scarcity, which in turn increases the demand. The increase in demand raises the value of the coin, offering investors a profit higher than their buying price.
- The burning of the token also allows investors to participate in the mining process which earns them rewards in the form of tokens. The higher the number of tokens burned the higher the number of rewards provided.
- As crypto burning helps maintain the stability of the price of the coin, investors can invest in the coin for the long term without worrying about the volatility of the market.
- Crypto burning also prevents DDoS attacks, making investors confident in investing in the platform without the tension of hacks and scams.
Limitations of Crypto Burning
Though crypto burning increases the demand for currency, they have certain limitations.
1. Volatility in market
The burning of crypto is announced on social media platforms and websites, creating short-term volatility in the crypto market.
2. Irreversibility
Crypto-burning is the transfer of crypto tokens to an inaccessible wallet; thus, once the transactions are processed, they can’t be reversed. They are permanently eliminated from circulation.
Final Thoughts
Crypto burning can increase the value of cryptocurrency as the burning creates scarcity, leading to demand. The tokens burnt are permanently removed from circulation and can’t be reversed. When a price surge takes place in the coin burnt, the person who burnt the coin faces a significant loss, whereas others who owned the token gain benefits.