Tokens, which are digital assets on a blockchain, regularly undergo something called a token burn. A token burn is a system in which tokens are generally sent to an unusable blokchainadress via smart contracts. By doing so the tokens get removed from the total supply and thus have a deflationary effect on the market.
What are tokens
A token is a digital asset existing on a blockchain like Bitcoin or Ethereum. These tokens can have several use cases within a blockchain. Common types of tokens include NFTs, tokenized assets and utility tokens. Down below is a short explanation of each of them.
NFTs
NFTs are unique tokens with distinctive characteristics and value. Think of it as art, with distinctive differences between art pieces. Due to this uniqueness can NFTs just like art not be exchanged on a one-to-one basis.
Utility Tokens: These tokens are used to access or interact with specific services or functionalities within a blockchain platform. For example, utility tokens may grant users access to decentralized applications (DApps), pay for transaction fees, or enable specific features.
Tokenized assets
Tokenized assets are tokens that have a physical (and sometimes digital) asset attached to them. This gives the owner of the tokenized asset, value and ownership proportionately to the stake that the token represents. As an example: lets say an house gets divided into 100 tokens with equal rights and value. In this case, each token would cost 1/100 of the price of the house but also grant 1/100 of the total voting rights in regards to the house.
Utility token
Utility tokens are the most “standard” token within crypto. As these are the tokens that are used on blockchain platforms. These tokens are used for gaming, paying transaction fees and using Dapps.
Out of all these types of tokens, it is common for the utility tokens to have a token burn once in a while. For NFTs and tokenized assets this is rarer but still not impossible.
What is a token burn?
A token burn is the concept of removing tokens permanently from the supply. This process is usually done by sending the tokens to an unusable blockchain wallet adress. This is commonly done by smart contracts. Within these smart contracts, mechanisms for regular or periodic token burning can be applied. Thus ensuring a regulated deflationary effect on the token, and potentially its price as well.
Reasons for token burning
Supply Control
One of the reasons that token burning occurs is that it is a way to control the total supply of a token. By burning a token, you make the token relatively scarcer. This can than increase the price of the token.
Furthermore can these token burning also be part of the tokenomics of a token. In which it can state that the token in questions wants to be deflationary after a certain amount of years. By the use smart contracts, this can be achieved. Another way for a project with such ambitions to become deflationary is to cut the supply of new tokens. This will cause it to not be inflationary. And due to the fact that tokens occasionally can get lost, the token becomes deflationary. The drawback of this approach however is that you never fully know what the deflation rate is, as you don’t know how many tokens get lost.
Compliance and Regulatory Reasons
Another reason why token burning exists is due to the fact that tokens (and cryptocurrencies in general) are sometimes listed as securities or subject to regulatory restrictions. By burning tokens, these companies can sometimes insure that they stay within there respective legal framework.
Token Migrations
And lastly, when a token transitions from one blockchain to another, it might occur that the old tokens are getting burned to insure that there are not tokens existing on both blockchains. This also generally makes the transition smoother.
Methods of burning
Besides the already spoken about regular token burning, which is setup to have a constant deflationary rate in line with the developers aim, another concept of burning exists. This is called transaction fee burning. In which you burn a percentage of transaction fee a user pays. By doing this you get a deflationary rate that is in line with the adoption of your token. Furthermore it might increase the value of a token, meaning that less tokens are needed for a transaction which in turn leads to a more cost effective (lower fees in the native token) and efficient (smaller amounts of tokens generally eases network congestion).
Few examples of token burning incentives
Huobi Token (HT):
Huobi, a popular cryptocurrency exchange, conducts quarterly token burns of Huobi Token (HT). The burning process involves using a portion of the trading fees collected on the platform to buy HT tokens in order to burn them. This creates scarcity and thus (generally) a higher price.
VeChain (VET):
VeChain, a blockchain platform with a focus on supply chain management and enterprise solutions, also utilizes a token burning mechanism. VeChain does the token burning periodically.
Ripple (XRP):
Ripple has done token burning in the past but isn’t as regular as a few others on the list such as VeChain. It utilizes a system for token burning however. And that is by sending an x amount of XRP tokens to an escrow service. With a portion of them being released and the others being burned.
Cardano (ADA):
Cardano has a built in treasury system called “voltaire”. This system ensures that a portion of the transaction fees are burned in order to reduce the total amount of ADA.