Destroying bitcoins and other cryptocurrencies may sound like one of the worst ideas possible. However, destroying, or burning, cryptocurrencies has actually been happening on a frequent basis and it’s not as crazy as it sounds.
By burning cryptocurrencies, the value of the remaining coins increases. This because most cryptocurrencies have a finite total number. For example, there are currently 16.7 million Bitcoins in circulation and there can only be 21 million Bitcoins in total. Imagine that 1 million Bitcoins will be burned and the demand for Bitcoin remains the same; in this case, the decrease in supply of Bitcoins will cause the price to go up.
There is one major concern with burning cryptocurrencies though: you destroy your own value. If I owned 1,000 Bitcoins and I burned all of them, the value of a Bitcoin will marginally increase, but I’d be left empty handed.
So what incentives are there for burning cryptocurrencies?
The New Dividend
The Iconomi platform has issued its own cryptocurrency (ICN) as a way to invest in their company. This means that owning ICN makes you a shareholder, or part owner of the company. As a part owner, you want to receive a share of the profits of the company based on your relative ownership.
Traditionally, this is done through dividend payments. However, due to major legal concerns with this in the crypto space, Iconomi pays their dividends in a rather creative and unique way. Based on the profits of the Iconomi platform, the company will continuously buy ICN cryptos back from the market and burn them.
By burning them, the crypto will increase in value due an increase in scarcity, and ICN holders will see the value of their ICN coins rise. Instead of paying dividends to its shareholders, Iconomi rewards them with an increase in value of their holdings.
Justifying New Coin Creation
Another argument for burning cryptocurrencies is that a newly created token actually has value because of it.
When creating a new cryptocurrency, developers are essentially creating value out of thin air. Developers create a cryptocurrency, interested parties invest by sending bitcoins, and the received investments are either stored or sold by the developers. Then the investors receive the new crypto, which now has a value because of demand, and a similar value is transferred to the developers. This implies a doubling of total value in the market.
By burning the received investment, the developers transfer value instead of creating it. This is because the burning makes the cryptocurrency more scarce as there is less of it. If bitcoin demand were to remain constant, every burned bitcoin would increase the price of a Bitcoin. This means that the newly created value of a cryptocurrency is based on the increase in the price of bitcoin. No value is created out of thin air, but the value of a new cryptocurrency is actually derived from the value of bitcoin.
Counterparty actually employed this tactic during their rather unique ICO. The developers of Counterparty created a unspendable, or unusable, Bitcoin address to which you could send your bitcoin to invest in the ICO. Instead of claiming the received Bitcoins themselves, the received bitcoins can never be used again. The address and the burning process were completely transparent and visible online. The burning was done using the proof-of-burn method, which will be defined below.
By doing this, trust was established since the developers of counterparty couldn’t profit from the ICO, and therefore couldn’t be tempted to sell the received bitcoins and buy a few lambos.
Paying For Transaction Fees
Another way the burning of cryptocurrencies has been employed is to pay for transactions.
Ripple is the biggest cryptocurrency doing this. For every Ripple transaction, a minor amount of that transaction is burned. By doing this, you pay for the transaction and the Ripple network profits from the usage of Ripple as there is less and less of their cryptos in circulation, which drives up the price. So, instead of paying the transaction fee to a miner or any one party, you pay the entire network.
Eliminating Unsold ICO Coins
Most ICOs set the number of coins that they will sell during the ICO. When the ICO coins aren’t sold out once the ICO ends, in some cases, the unsold amount ends up in the wallets of the company. This means that they have received free money, since the coin has gone up in value because of the ICO. They can simply sell the remaining cryptos on the market and make a nice profit on them.
Some ICOs have a policy of burning any ICO coins that are unsold. An example is Neblio. They fulfilled their promise to burn the coins that weren’t bought during their ICO. In this way, they ensured that they were only going to use the value received from the actual sale of their cryptos to develop their blockchain application. Thus, the income of their ICO was based on the actual demand for their crypto, which is only fair.
Burning Crypto and Proving the Process
When burning cryptocurrencies, the coins that are going to be burned are sent to an address which can never be accessed or used. Usually, this address is invalid which makes it unusable. Basically, the same thing happens if you were to send bitcoins to an address that doesn’t exist on the Bitcoin blockchain; those bitcoins will be lost forever in cyberspace.
Thus, to burn a cryptocurrency, you send the cryptos to a verifiably unspendable address. By doing this, the cryptos are taken out of circulation because they can’t be used anymore, ever. The address can’t be accessed and can’t be used for trades.
To provide investors with evidence that the cryptocurrencies have actually been burned, a method has been developed, which is called proof of burn. This method employs the same logic as blockchain technology, namely that trust can be established by the system without the need for third parties to verify actions and transactions. Proof of burn provides anyone interested with empirical and untampered evidence that the cryptos have actually been burned.
With the continuously rising value of cryptocurrencies, burning them is definitely something you don’t want to do to yourself. However, for crypto-issuing companies, it can provide a system for justifying value creation, paying for transactions and as a means to pay out dividends to investors.
When a company claims that they’re going to burn cryptocurrencies, always make sure they employ the proof of burn method and keep track of the process.