The world of cryptocurrency has many unique concepts and one of them is coin burning. Some Initial Coin Offerings (ICOs) and major exchanges with their own native tokens integrated this mechanism for unsold tokens at the end of their token sale and/or add value to their coin respectively. Let’s get started on the basics.
Understanding Coin Burning
Coin burning is an intentional process of ‘burning’ or destroying coins by making it unusable. This is done through sending the coins to an “eater address” (also known as a “black hole”) where no one can access them. The coins cannot be recovered because the private keys of this address are unobtainable. These transactions are recorded on the blockchain and you can verify them as well.
What is Proof of Burn?
Common consensus algorithms are Proof of Work (POW) and Proof of Stake (POS). Proof of Burn (POB) is an alternative to these two algorithms and addresses the energy consumption issue of POW. In coin burning, the miners send some coins to verifiable “eater addresses”; burn their coins to mine in a POB consensus protocol. As the blockchain is transparent, anyone can verify the transactions easily. Users are also usually rewarded with mining rights.
Reasons for Coin Burn
There are multiple reasons why cryptocurrencies are burned:
- Some cryptocurrencies use POB as their consensus mechanism as it requires the users to burn portions of coins to gain incentives or even pay for transaction fees.
- The rules of supply and demand also apply to cryptocurrencies. Coin burn reduces total circulation, control inflation and strengthen the value of the token.
- During ICOs, some issuers promise to burn unsold coins to reward token holders or reinforce commitment to a project’s growth prospect.
- Projects that accidentally make errors such as excessive coins issued or created invalid address for transacting funds can correct them with token burns.
- Apart from being a way to help in project’s growth, coin burn is also effective against Distributed Denial of Service Attack (DDOS) and prevents the network from spam transactions.
A coin burn removes tokens in supply as they are sent to an address which cannot be spent. Generally, periodic coin burning can help to positively impact the value of tokens* and reward holders. Nevertheless, this method does involve certain wastage of resources and allow greater mining power to users who are prepared to burn more money. It is imperative for interested users to research about the projects and cryptocurrencies before participation.
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