What are buybacks and token burns? — AAX Academy
The practice of self-investment by companies is not new and has been a staple instrument of price stabilization (or inflation) on the traditional financial market for decades. The development of the crypto market is largely associated with the migration and adoption of financial strategies from the traditional market with their consequent application and evolution to suit the needs of decentralized assets.
With the turbulence of price dynamics and the conundrum with various types of tokens circulating on the market, blockchain-based projects have started applying two types of approaches to control their emissions and stimulate price. The two most popular tools are buybacks and token-burns. And though both approaches essentially serve the same purpose, their mechanisms and ultimate goals in terms of price influence are different.
Token Burns and Buybacks
The practice of token-burns is when a project permanently removes some of its tokens from circulation and sends them to a zero address, essentially eliminating them from existence. The tokens themselves are either repurchased from the community, or simply extracted from existing pools to change demand and supply dynamics and affect price.
As for buybacks, the practice is a direct derivation of the buybacks used in traditional finance. In essence, a buyback is when a project, or company, uses its own cash resources to repurchase some amount of its tokens or shares from holders at market price. The repurchased assets are then stored on the wallets of the entity, not destroyed, and neither are they released back into circulation immediately.
The practice of buybacks is an important instrument in the arsenal of companies seeking to stimulate the market and drive up the value of their share prices, while retaining ownership of their own shares for later use. In the crypto world, the practice is identical with regards to tokens that projects buy from the community and store on their own wallets.
Are buybacks good for investors?
The reasons why projects resort to buybacks can be many, including the need to deflate the amount of tokens in circulation due to errors in economy calculations, the desire to artificially inflate token prices, drive speculation, hype generation, as a gesture to token holders or as a way to simply reorganise allocations.
Oftentimes, the buyback is conducted for internal project reasons or for increasing liquidity and lowering price volatility. The law of supply and demand dictates that lower supplies tend to stabilize prices in the long-term, while larger volumes of available assets result in lower interest towards them due to the negation of the scarcity principle.
All of the reasons for buybacks are subject to criticism, as they immediately arouse a reaction from the community, which starts asking questions regarding the logic behind such decisions. Regardless of criticism, the holders of tokens subject for buyback will either see buybacks as an opportunity to sell their tokens, or to buy more and double down on an investment in anticipation of price appreciation.
Are buybacks the way forward?
Among some of the projects that have conducted buybacks are Binance, Nexo and others. The reason for Nexo’s buyback, for instance, was that the core development team felt confident of their asset’s extreme undervaluation. As a result, they decided to reduce the amount of project tokens in circulation and thus assist in the correction of the market price.
Buybacks in crypto space are a mirror reflection of their traditional financial market counterparts that are used for adjusting the amount of a company’s assets in circulation. The reasons for such programs are many, but the end result is usually a significant boost to the asset’s price.
Originally published at https://academy.aaxpro.com on May 6, 2021.
