Cryptocurrencies are known for their whipsaw volatility. The meteoric upswings and gut wrenching downturns make even the most seasoned investors uneasy. These considerable shifts in token price are not only alarming for investors but also for the project teams. Many protocols hold large amounts of their native token in their treasury, and price swings can have a severe impact on the funding of further development. To offset these swings, or at least try to mitigate them, development teams sometimes use token buybacks and burns. In this article, we’ll be exploring what this means, what the rationale for doing so is, and the impact this can have on project development.
What Is A Buyback?
Buybacks are not a new concept and have existed in the stock market for decades. A buyback occurs when the firm that issued the stock purchases the shares back from the market. This reduces the overall supply of the stock, which, if demand remains constant, leads to an increase in price. The same concept can be applied to blockchain and cryptocurrency. Tokens can be bought at the market by the development team, reducing the available supply and supporting the token price.
What Is A Token Burn?
Once the tokens have been bought back from the market, the question remains of what to do with the tokens. Development teams have a couple of options here, and the decision will vary depending on market dynamics and team goals.
The first option is to take the tokens into the treasury and hold them as an asset. This removes those tokens from the supply, but it does not preclude them from being re-released at a later date when market conditions change. The second option is to burn the tokens. This approach permanently reduces the token supply as the tokens are no longer recoverable. This is generally achieved by sending the tokens to a designated public burn address. The tokens are visible at this address, but no one can access them ever again.
Why Are Buyback And Burns Useful?
Development teams and projects have a number of reasons for implementing a token buyback and burn. The most common is related to price action. Crypto markets are incredibly volatile, and it’s not uncommon for the token price to swing wildly. This can prove to be problematic for teams as treasury holdings often consist of a large amount of the native token, but if the treasury is diversified then it’s less of an issue. For investors, however, these token swings can be difficult to stomach.
Even if swings in token price are being driven by market forces, it’s possible for token holders to lose confidence in a project. This loss of confidence can have a significant impact on the community, something that development teams definitely need to be mindful of as without their community, the project has nothing.
In this instance, token buybacks and burns can be a powerful tool for development teams to make use of. In doing so, it demonstrates to the community that the team is not only aware of the position they may be in, but is also taking steps to support them through it. The reduction in supply that a token burn leads to can have a significant positive impact on price action going forward, and this is often what investors are looking for.
Buybacks, Burns, and LUNA
In the wake of the recent LUNA/UST collapse, Do Kwon and the team from Terraform Labs (TFL) have put forward a proposal making use of the above mechanics.
“Currently, the burning of UST is too slow to keep pace with the demand for excess UST to exit the system, which is hindered by the BasePool size,” reads the proposal. “Eliminating a significant chunk of the excess UST supply at once will alleviate much of the peg pressure on UST.”
Terra plans to burn the nearly 1 billion UST (approximately US$690 million) in the community pool while increasing the Base Pool of LUNA to 100 million tokens. By virtue of how UST and LUNA come together to support the peg, this would increase the minting capacity to over $1 billion. In turn, this will help speed the outflows of UST from the system, theoretically pushing it back closer to its $1 peg while concurrently pushing down the price of LUNA.
TFL are not the only organization with plans for LUNA. MEXC, a Singapore based exchange, have announced their own special recovery plan, also centred around buybacks and burning of LUNA tokens. The exchange has proposed to buy LUNA from secondary markets using trading fees from LUNA/USDT, and then burn the newly purchased tokens, removing them from the supply. This should, as discussed above, provide some support to the price which is down well over 99% since its peak.
Putting It Together
Token buybacks are one of the powerful tools development teams have at their disposal when navigating the difficult task of developing a project. Burns can also be utilised to permanently reduce the circulating supply of a token, which can also accomplish a similar effect. By reducing the available supply, a buyback and burn can support token price, and help reduce some of the volatility that characterises the crypto space. These tools, when utilised correctly, are a potent way for development teams to reconnect with the community, show them they care about their wellbeing, and refocus on delivering a top tier product.
