Have you ever found yourself scratching your head, wondering how Bitcoin, the king of cryptocurrencies, skyrocketed in value in just under a decade? Bitcoin is valuable due to its revolutionary technology, decentralized nature, secure transactions, fast and global transfer capabilities, and growing network effect, which collectively make it an attractive alternative to traditional financial systems. Apart from these unique characteristics, BTC is programmed so that it’s scarce, and there will only ever be 21 million Bitcoin in existence. This scarcity is one of the many factors that ensure that the demand for Bitcoin will remain high and its value will remain stable or increase over time. This article discusses why scarcity matters and how different projects approach it.
Why Should Token Supply Be Limited?
Tokens and coins in the cryptocurrency market try to maintain scarcity in various ways. One way scarcity is ensured in the crypto market is by limiting the supply of tokens like what Bitcoin does. Additionally, some tokens are not created with a predetermined amount of tokens. Therefore, they follow a token-burning policy to ensure the scarcity element exists. However, the price of a token is not solely dependent on burning tokens, and it is supply and demand that ultimately determines the price of an asset in the market.
For example, ETH is programmed with an infinite supply, and an amount of ETH is burned during each transaction. In August 2021, Ethereum released the EIP-1559 protocol (EIP stands for Ethereum Investment Protocol). According to the protocol, a portion of the transaction cost or gas fee will be burned for each transaction conducted on the Ethereum blockchain.
In fact, the value of tokens can be influenced by the supply of tokens and their price volatility. This is why many people argue that token burning could be a good idea for cryptocurrencies like Bitcoin and Ethereum, as it would help them stabilize their prices in the long run (i.e., reduce volatility). Let’s see why burning tokens happens and how it affects the tokens. In this article, we will discuss what token burning means and how it affects the token price in the future.
What Does It Mean to Burn Crypto Tokens?
Not all burnings are bad! Actually, in the world of cryptocurrencies, burning tokens is good news. It’s because of its deflationary effect. By burning tokens, the issue is essentially taking them out of circulation, reducing the total supply and increasing the value of the remaining tokens. Token burning is often used to increase the value of a cryptocurrency, as the reduced supply increases the demand for the remaining tokens.
Token burning can also be used to incentivize users to hold onto their tokens, as the reduced supply can increase the value of the tokens held by users.
Token Burning in Different Projects
Different crypto projects have different token-burning policies. For example, Binance Coin (BNB) is a utility token used to pay transaction fees on the Binance exchange. Binance burns a portion of the BNB tokens each quarter to reduce the total supply and increase the value of the tokens.
As another example, Huobi Token (HT) is an exchange token used on the Huobi exchange. Huobi burns HT tokens on a quarterly basis to reduce the total supply and increase the value of the tokens.
In CrowdSwap, a decentralized finance (DeFi) project, token burning is planned monthly for the year 2023. The project burns 20 million CROWD tokens on the first day of every month to keep the supply low. So, in total, 240 million CROWD will be burned in 2023 and removed from circulation.
How Does Burning Tokens Affect the Token Price?
Burning tokens can decrease the total supply of a token by increasing scarcity. This scenario mimics gold, for which demand is high, and supply is depleted.
Although token burning can affect the price of a cryptocurrency token, it is not guaranteed. Burning tokens can increase the price if there is strong demand for them. However, the price of a token is ultimately determined by the market forces of supply and demand, so token burning may not have a direct, immediate effect on the price of that token.
Like other assets that people tend to hold, cryptocurrencies need to keep the supply low to increase their demand. Put another way, scarcity increases its price because it creates a higher demand for a limited supply. When the supply is limited, people are willing to pay more for the asset as they become scarcer. This increased demand leads to an increase in price over time, albeit not in a direct and immediate fashion.
Token burning is a common way of ensuring scarcity among various cryptocurrency projects. The cryptocurrency issuer can remove tokens from circulation by burning them. It is a method for lowering the number of tokens in use and raising the value of the tokens still in circulation.