Geek Culture
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What Is Coin Burn and Why Does It Make Crypto Investors Happy?

Organizations have used methods to stabilize money for decades. Investors like stability, so crypto needs to turn their frown upside down.

Image of a Bitcoin on fire.
Image courtesy of Canva

I bought a bag of doughnuts yesterday. I was so happy when I began to eat them. I was hungry, of course, which contributed to my happiness, but also I knew there were more doughnuts in the bag. I had a good supply. However, as I ate more, my supply dwindled, and toward the end, when I reached into the bag, I felt there were only a few left. Still, I wanted to taste more, and my brain calculated that I would like to taste more doughnuts than were left on the bag. Suddenly, my doughnuts became a source of concern as I was running low. That bag of doughnuts cost me $3. Yet, if someone could have brought me another bag of doughnuts to my door, I might have paid $5 because it wasn’t worth going to the store again. The value of my doughnuts increased as my supply decreased. Therefore, I experienced the effect of supply and demand.

But I don’t want to have to pay $5 for doughnuts. That’s inflation. I want to pay $3 again with the addition of someone delivering them to me. I need cheaper doughnuts. If the store would lower the price to $1.50, I could pay someone $3 to bring my doughnuts. That’s deflation. The store’s supply would have to increase, so they want to part with their doughnuts at a lower price.

These principles drive the heart of our economic system, from our fiat currency to stocks, and now, cryptocurrency. Sometimes during financial instability, governments, businesses, and organizations must use active methods to stabilize a currency if there is too much of it in circulation or too little. Today, we will focus on coin burning, but we must also look at fiat currency demonetization and stock buybacks to understand it. When you finish reading, you’ll understand coin burning, why organizations do it, and how it can benefit you.

Let’s get it.

What is Coin Burn?

Demonetization, stock buybacks, and coin burning have similarities, but more than a few differences. For instance, demonetization erases the status and value of the legal tender. In comparison, stock buybacks allow companies to reclaim stocks from the open market. And, you guessed it, coin burning allows developers or communities to destroy cryptocurrency tokens. However, it’s worth discussing each of these, in turn, to hold comparisons in your mind when thinking about what coin burning is.

What is demonetization?

To demonetize a currency is to strip it of its legal tender status. When a government changes currencies, they demonetize the old ones. For example, President Ulysses S. Grant signed into action The Coinage Act of 1873. While meant to restructure minting procedures, it was also an act to move America away from bimetallism. Before 1873, miners and farmers could take their silver to the government for minting into silver dollars and use it as legal tender. After the passage of “The Crime of 1873,” they were turned away from the mint or offered paltry sums for a coin equivalent, exceeding no more than $5. After continued debate, the government repealed the act 12 years later. However, demonetization doesn’t always have adverse effects. Such as the case in 2015 with Zimbabwe. It saved their economy. During 2015, the country’s hyperinflation rose to 231 million percent (I wanted to write that out for clarity). In response, the government cleared out all of their currency over three months and replaced it with three different ones from other countries, including the United States Dollar. So, demonetization isn’t something approached lightly. Yet, the act of doing it tries to serve a positive purpose — stabilization. Over a century later, the Securities and Exchange Commission legalized a similar non-destructive method for stabilizing a company’s economy: stock buybacks.

What are stock buybacks?

A stock buyback or share repurchasing is when a company uses its available cash to buy back shares of stock from the marketplace. For example, if Apple stock suffers, one recourse for maintaining or increasing value is buying back its supply from the open market. With Apple reducing its open market shares, they become more valuable as long as demand holds or increases. However, stock buybacks haven’t always been legal. Through most of the 20th century, the SEC considered stock buybacks illegal and a form of market manipulation. Yet, during Ronald Reagan’s presidency and subsequent push for deregulation, the SEC passed rule 10b-18. The statute allowed companies a legal process to buy back their stocks, and it opened the floodgates. Still, stock buybacks aren’t wholly unregulated. In 2003, the SEC amended the rule requiring companies to disclose detailed quarterly information on every stock buyback for the period. Also, companies must meet specific criteria before making the purchase. So, governments and businesses possess methods of stabilizing their economies in certain circumstances, but where does that leave crypto?

Coin Burn

Coin burning contains characteristics of demonetization and stock buybacks. When someone burns a crypto coin, it is lost forever. However, the person initiating the coin burn compensates the burner with new coins or a different type and comparable value. Developers of the cryptocurrency coin or a majority consensus within the crypto community can initiate a coin burn. For instance, Ethereum’s “London” hard fork required them to burn a vast amount of their Ethereum coin called ether. The burning of these coins is a part of increasing the network’s ability to scale along with changes in the code to transform how transaction fees work. Unstable transaction fees and slow scaling to handle more transactions have been an ongoing issue for Ethereum. Therefore, to regulate the flow of ether, they bought back coins from investors and burned them. It’s easy to think of burning or shredding a dollar bill to take it out of circulation, but how is done with crypto? Developers and communities send coins to a unique address (wallet) where no one holds the private key. It is called an un-spendable address. Therefore, if no one has a private key, the coins are useless and effectively destroyed. Other members validate the community members (miners) who participate in the burn on the network, and the burners are rewarded for their “work.” Developers call the algorithm proof-of-burn. So, communities burn coins in service to further develop and improve the existing functionality of the network, but are there any other reasons to burn coins, such as economic stabilization?

Why would someone burn coins?

The primary reason developers or community members agree to burn coins is inflation.

Inflation

Using Ethereum again as an example, there is no limit on the number of ether miners can mine. However, unlike Bitcoin, which has a limit of 21 million tokens, Ethereum must contend several more factors leading to inflation. It is logical as a resource approaches infinity, it would essentially become free, and although block creation speed can help, Ethereum’s blockchain is faster than Bitcoin’s. So, you can see demand for ether slump as supply increases and the price drops. Hello, inflation. Yet, Ethereum is not without control, such as mining difficulty, but it isn’t enough. After all, one of Ethereum’s selling points is its faster transaction times. For example, when U.S. inflation hit highs not seen since 1991, Ethereum took a huge nose dive below the $2000 mark. However, Ethereum’s move to proof-of-stake stabilized the coin’s rollercoaster, and part of that move was coin burn. And investors typically love it when the crypto market stabilizes from an inflation hit.

How does it affect investors?

Coin burn typically makes investors happy

No one likes inflation, including crypto investors. With crypto’s extreme volatility compared to stocks, owners already ride a tumultuous rollercoaster. Fiat inflation and traditional market forces impact crypto’s performance on top of its natural ebb and flow, so investors can retain confidence in their bets when developers introduce a stabilizing force into the market. For example, in April 2018, Bitmain’s Antpool (a mining pool) announced burning 12% of its BCH. Their mission claims to fulfill the original purpose of Satoshi Nakamoto and that Bitcoin has become a nest of sellouts to the dream. Therefore, they created the Bitcoin Cash hard fork. The burning of their coins certainly had the desired effect as BCH rose $200 per token. Yet, it was on the heels of an already impressive climb that might have been from the anticipation of the mining pool’s move. So, the rules of supply and demand kicked in, and investors saw rapid gains and stabilization of their earnings. Yet, coin burn doesn’t guarantee prices will go up. If developers don’t understand correct coin burn timing, it could result in no change at all. Typically though, coin burn achieves its goal of squashing inflation, and investors feel an overwhelming sense of confidence and happiness as their portfolios grind along.

Conclusion

The result of coin burn is something governments, businesses, and organizations strive for in times of need: stability. Through demonetization, stock buybacks strategies, crypto organizations can achieve the same result with coin burn. Typically, coin burn increases the price of the remaining coin supply through the logic of supply and demand. However, sometimes isn’t the case. Then, coins show no movement in price at all, which can shake investor confidence. Yet, crypto investors are a different breed, and HODLers understand that sometimes you must weather pretty severe storms to win in the end.

Have you ever participated in coin burn?

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T.C. Gunter

T.C. Gunter

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T.C. wants you to read his words. Hoping that the words transform you. Not in some grand way like spiritual rebirth. But more like a act of kindness or a smile.