What Is Token Burning and How Does It Affect Price?
Cryptocurrency can be difficult to understand in its entirety, mostly because it is unlike almost any other asset on earth. For example, many tokens have burning mechanisms which are used to ensure the token functions.
Burning is a unique mechanism used to maintain the value, security, and stability of certain cryptocurrencies, and while it’s not always associated with price changes, it can be. Read on to learn everything you need to know about token burning and its effect on prices.
What is Token Burning?
Just the word “burning” can instill confusion as people start to picture burning piles of money—but we weren’t lying in the introduction. Burning is necessary on some cryptocurrency blockchains, which is what makes it an asset unlike any other. Unlike what you may be picturing, burning crypto doesn’t involve fire—rather it is a deletion or removal of certain tokens from circulation.
Because cryptocurrency can’t be “deleted” in the traditional sense, the word “burn” has come to be associated with this act of removal. In most cases, the token is sent to a non-accessible address ensuring it will never enter circulation again. This address is configured only to receive tokens and often doesn’t have the specifications necessary to send tokens, ensuring that not even malicious actors can access these tokens. The transaction is publicly recorded, establishing that those tokens are no more.
Why is Token Burning Important?
Those with a scarcity mindset may wonder why blockchains are design with token burning in mind. The answer isn’t cut and dry, as different blockchains burn crypto for different reasons. Below are the main reasons a blockchain may be established with a token burn mechanism.
· Supply control/inflation management
· Ecosystem necessity/design
Basically, when cryptocurrencies are designed they are designed for a specific purpose. Those that are stablecoins (used for cross-border payments) need a burn mechanism so the stablecoin can be “eaten” or “removed” by the system when the backing is removed. Other tokens, which are designed as currency (like Dogecoin) can be created in perpetuity and need a burn mechanism to keep them from becoming inflationary (spoiler alert: Dogecoin does not have this burn mechanism).
Some blockchains utilize a burn mechanism because of the perceived price impact. We will discuss this below but it is important to note that, other than controlling inflation, burn mechanisms do not automatically influence price—though many scam blockchains will push this idea to convince you to invest.
How Does Token Burning Affect Price?
As we mentioned above, simply having a burn mechanism does not automatically influence the price of a cryptocurrency. In the past, large scam blockchains have advertised “token burns” hoping people would buy in, convinced that the price would increase the moment a token burn took effect, this is never the case.
We want to make something clear, a token burn mechanism can help stabilize the price of a blockchain token, by reducing inflation in a blockchain which includes constant token creation, but it cannot, ever, directly influence price.
Remember above, when we mentioned stablecoins? Burning tokens is a necessity in most stablecoin protocols. However, stablecoins are pegged to the value of a fiat asset—meaning this burn mechanism has NO effect on the price of the stablecoin. The same idea applies to non-stablecoin platforms which utilize a burn mechanism—sometimes it is a requirement of the platform and it will not affect pricing of the token.
That being said, there are cases where platforms that don’t normally burn tokens as part of their protocol, announce a token burn. After this burn happens, the price may rise. However, it is critical to understand that it isn’t the burning of tokens that raises the price. Rather, it is the change of market sentiment (people think the price will go up to they buy in), scarcity mindset (people always want things that might not be available later), and an overall reduction in inflation. Again, prices may increase after a token burn, but not because of the token burn itself—in fact many of these announcements do more of the work than the actual token burn.
Generally, platforms that need to burn tokens from time to time are bad news—because it means the protocol itself doesn’t control the inflationary aspect of the blockchain. Bitcoin gets around this by having an established cap, but Dogecoin, a popular, not-very-safe alternative, has no cap and may someday need to burn coins. Of course there are some exceptions, like BNB Coin, but in general we recommend investing in platforms that use other controls to stabilize their price (as these tend to be more decentralized), or those platforms which have a burn mechanism built into them as they tend to be more stable.
Wonder how token burns can be bad news for a blockchain? Just take a look at the TITAN and IRON Algo disaster.
Should You Buy a Token Before a Token Burn?
We do not recommend making any token purchasing decisions based on token burn announcements. We hope you understand by now, but token burning does not have any actual effect on prices. While it can cause prices to fluctuate, it is almost always done to promote long term stability of a blockchain, though scammers will take advantage of it to draw in more buyers.
That being said, if there is a token you already had your eye on and they announce a token burn, it may not be the worst time to buy in. But that is because we believe once you make the decision, buying in soonest is best (because timing the market is impossible) regardless of token burn announcements.
Overall, token burning is a necessity in the cryptocurrency world, and despite common belief it does not cause large price spikes. Rather, token burning is used for blockchain stability and any price spikes which result are generally because of a misunderstanding of the news of the pending burn rather than the actual token burn itself.
