Note: This post has been written by a WazirX Warrior as a part of the “WazirX Warrior program.”
Something burning? No, we are not lighting a fire to some currency.
Coin burn is the terminology used when coins are removed permanently from the current circulating supply. This process is accepted by a lot of cryptocurrency projects such as WRX token for WazirX and BNB token from Binance. WRX completed its second quarterly burn in October.
This is done by sending a portion of the coins to an ‘eater address’, which is often referred to as a ‘black hole’ since the private keys to that address are not obtainable by anyone. Therefore, any coins sent to an eater address are unrecoverable and cannot be used again, forever! These coins are effectively taken out of circulation and are publicly recorded and verifiable on the blockchain.
This address can be seen by all nodes but is practically frozen forever.
Background of Coin Burn
Cryptocurrencies are not the first to discover coin burning as a concept. In fact, this process is highly similar to the idea of a publicly-traded company buying back stock. Companies of this type use cash on hand to buy back shares of common stock, thereby reducing the total shares outstanding.
Why is Coin Burn done?
Coin burns are done for multiple reason and benefits:
- More Effective Consensus Mechanism
Crypto projects that work on Proof-of-Burn (POB) mechanism, POB is a unique way of achieving consensus in a distributed network, requiring participants – miners and users.
Demand and Supply’s economics ensures the value of the coin increases when the demand remains the same but the supply is reduced by the coin being removed from the current stock.
The above picture shows the hyperinflation can be devastating to any economy and the burn process protects the currency from inflation.
Coin burning acts as a natural mechanism to safeguard against Distributed Denial of Service Attack (DDOS) and prevent spam transactions from clogging the network. Coin burning creates a cost for executing a transaction in the same way how users pay a small fee for sending Bitcoin (BTC) or pay gas for smart contract computations in the Ethereum blockchain. Instead of paying fees to miners to validate transactions, some projects have integrated a burning mechanism where a portion of the amount sent is automatically burnt. Ripple (XRP) is a project that utilizes this burning model.
- Sign of Long-term Commitment
Categories of Coin burn
Coin burn can be divided into two categories:
In simplified words, any coin burning mechanisms that have been hardwired into the coin’s DNA (codebase) belong in this category.
- Economic policy of the project
Coin burns are unique to cryptocurrency and show a system where a currency or asset’s deflation is prized. This is in stark contrast to fiat currencies, especially at the moment, where dollars, euros, yen, and several other major currencies are being printed in their trillions.
This floods the currency market and causes inflation in an exactly opposite manner to the cryptocurrency token burn. Inflation is a danger for currencies as it devalues them significantly, and this is why cryptocurrencies that go with a token burn are looking to take advantage of deflation.