Hello, amazing Sphere community! There are a lot of opinions around the idea of token burning and the question of if it is good or bad for projects and protocols to hop on the token burn bandwagon.
This article aims to educate you on the purpose, process, and impact of token burning on crypto projects and also the potential benefits it may bring to investors.
What is token burning?
Token burning is the act of permanently taking specific amounts of tokens out of circulation. It is the destruction of a token or a number of tokens.
Projects that adopt the token burn mechanism can decide to do it on a monthly, quarterly, or yearly basis, depending on the goals of the project issuing the token.
Token burning is an irreversible process and can influence a project’s tokenomics positively if done correctly and under the right market conditions. If done incorrectly, it can affect a crypto token’s price negatively.
How does token burning work?
Before burning, the project decides on the target amount to be burnt and how often the burn will occur. After deciding, a smart-contract code is written to perform the burn.
The selected token amount is sent to a wallet address known as a “burner wallet”. In this wallet, tokens only go in, never out.
Why do projects burn tokens?
Price Action
Projects burn tokens mainly to decrease the supply of the number of tokens in circulation which should increase the token’s price.
When there is a decreased supply of a product, and demand stays the same or increases, the price will inevitably go up.
For instance, Bitcoin, the largest cryptocurrency by market cap, has a total supply of 21 million.
Its supply hasn’t changed but Its demand has increased over the years and that is one of the reasons why it is valued at this current price.
If you were to reduce the supply of Bitcoin to say, 10 million and its demand increases, the price will skyrocket.
Projects aim for this effect when they burn tokens and that is why the majority of crypto projects
have a burning mechanism.
Proof of burn
Some Blockchains use a consensus mechanism system called “proof-of-burn” to incentivize miners that burn their tokens. This burning gives them access to participate in the mining process.
The burned tokens cannot be recovered or spent by anyone, ensuring their scarcity and making them unusable for future transactions.
Now you know why burning occurs. But what are the benefits of token burn and are there any drawbacks?
Benefits and drawbacks of token burning
Benefits
Increased token value: As previously highlighted, token burning causes scarcity which can increase the perceived value of the token. This deflationary model can influence the project’s price in the long term.
The second largest token by market cap Ethereum introduced a burn mechanism feature that helped reduce the high gas fee issue and also made the ETH token deflationary.
From the graph collected from Glass node above, we see Ethereum’s price increase, relative to the token-burning process.
Incentivizing long-term holders: Token burning can act as a means to encourage the long-term holding of the token.
When the token burn mechanism is put in place, investors that believe and trust the project will see the potential price increase of the token and may decide to hold the token in order not to miss out on future possibilities.
Reduced volatility: Another benefit of burning is a stable token price activity. With fewer tokens available for trading, it will be harder for whales to manipulate the market and cause huge dumps on the market.
Drawbacks
Token burning when done correctly, brings a positive effect but when there is a poor tokenomics structure, token burning will not solve the problem and might even hurt the project’s price. some drawbacks of token burning include the following;
The misconception of value by investors: If the token burning process is not communicated properly to investors, they may view it as market manipulation or destruction of value. This might make them lose confidence in the project and make them sell their holdings.
Irreversibility: Token burning is a permanent action. If the burn was not carefully thought of, there may be regret later when the project’s activities change.
Insignificance of small burning: Sometimes the token burn is irrelevant if a substantial amount is not burnt. If a crypto project with a circulating supply of say 100 billion burns 10 thousand tokens every month, the burn will not have any effect on its value.
Approximately 4 million ETH are burned each year. With Ethereum’s total supply of 120 million, this burn is sufficient enough to cause a positive impact on the price of Ethereum.
SXS token burn
During the time of the SXS launch, we did a poll to know what the community thought about SXS burning. More than 60% of the community voted on a monthly burn process. This week, we are going to enable this feature.
The team has carefully designed the SXS burning process and we will ensure that this burning process is transparent and verifiable. Keep an eye on our official channels so you don’t miss out on any future developments. Also, Follow us here on Medium to get more insightful stories.
Do you know Sphere is the official launchpad for Mantle? Click here to read more about this partnership.
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