Burning Benjamins — The Theory of “Burning” in Tokenomics
Exploring the economic impacts of Token Burning
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Economics, while a critical element in the functions of an advanced human civilization, has always been inherently experimental.
The most recent frontier in economic experiment arrived in the form of cryptocurrency. Digital networks that provide all the economic, mathematical, technological, and social principles necessary for the existence of a monetary system.
One aspect that a sound monetary system must have is the existence of a supply module. A system that is able to respond to & balance out the supply vs. demand dynamics which take place in open markets. This supply module has three possible general variants:
💫 expand 💫
A system where the supply is growing through means such as inflation. Used for environments where demand for an asset/currency is constantly growing. Each unit of currency devalues over time.
💢 contract 💢
A system that serves as a countermeasure to inflation. Reduces the supply of circulating assets/currency. The value of each unit can be artificially stimulated to grow.
♻ remain unchanged ♻
A system with a fixed maximum supply of an asset/currency. Used for environments with assets that act as a good store of value.
In the name of addressing these supply-side nuances of economic monetary policies, one promising mechanism focused on the “contraction” of monies came to the forefront as a byproduct of cryptocurrency experimentation known as “Burning” 🔥
The theory behind burning is simple;
Removing assets from circulation to drive price appreciation.
If assets are removed from circulation, then their value is retained in the network, and the unit value of each asset increases.
Typically whenever assets are “burned” they are sent to an unspendable address. An address to which nobody holds the private keys to and therefore nobody controls. Assets sent there are irretrievable.
A prime examples is the 0x00 ethereum address, (found here) also known as the void address. In which there is over $700,000,000 worth of tokens at that address at the time of this writing (& more being deposited over time).
The economy can be seen as a state machine;
Yesterday $400B was circulated in the trade of commodities, today there was $389B and tomorrow there might be $422B. It transitions from one version into another version of itself.
Let's say network A is worth $10,000,000.
There are 1,000,000 units - so each unit is worth $10.
There are 1,000,000 holders - so each holder has 1 unit ($10 value).
The network's monetary policy is a 10% reduction in supply annually.
Let's take a look at how burning would working a perfect world:
But we do not live in a perfect world 🌏
In reality, there is a multitude of factors that influence the price of an asset as a result of having a burning mechanism.
As the circulating supply decreases so does its open market liquidity; just because the price was in theory supposed to rise, does not mean that the open market participants will begin automatically offering $10.50. Likewise, this also means that the current holders must be satisfied with selling at a point they find fair. If there are no buyers at $11 & no sellers at $4 then the price can remain stagnant.
Moreover, investors and the economically apt audience will find ways to game the system; with a huge price run-up to the burn event, then a radical spike in price followed by an immediate sell-off because the speculators of Burning economics left.
All in all, Burning is a viable attempt at balancing out economics.
But burning, as a mechanism, is not meant to be adapted to every form of money. Some monetary policies are more fit to serve as a medium of exchange (cash) others are more fit to serve for a store-of-value (gold/Bitcoin). Burning lands itself somewhere between the two.
Is the holy grail which mends all monetary woes?
Unlikely, but who knows what's possible.
(if you think otherwise, would love to hear your standpoint!)
Some cryptocurrency projects that implement token burns:
- Binance (BNB)
- XRP (XRP)
- Kyber Network (KNC)
- Eidoo (EDO)
- KuCoin (KCS)
-Unus Sed Leo (LEO)
