Since token mechanics can be designed in various ways, teams around the world become very creative. They aim to make their tokens valuable/useful to investors while avoiding regulatory risks. Meeting both criteria is not an easy task as the legal framework for digital assets is still evolving.
One way to let investors benefit from their token are token burn events. Instead of giving out „dividends”, tokens are bought back from the market and burned.
A token burn is the destruction of a certain amount of circulating tokens in order to reduce the supply. Financially, this method works similar to a „dividend” payout. If 10 % of the supply is burned, the value of that 10 % is spread proportionally to the people still holding the remaining 90 % of the token.
Technically it works as follows:
- Tokens are sent to an address from which no one can own the private key of.
- The token smart contract has already integrated a .burn() function that reduces the total number of tokens trackable on the blockchain.
The economic effects of token burns can be summarized as follows:
1) The remaining tokens become more scarce
The total supply of the token decreases forever. But does it make the remaining ones more valuable? That might not always be the case.
Price determination exclusively happens at the marketplace, driven by the interaction between demand and supply. It’s dictated by how much investors are willing to pay. Just because there are less tokens in circulation does not mean that potential investors are willing to pay more for the remaining ones.
2) The proportional share of an investor increases
Example: You hold 500 Tokens which represents a 5% share. After 50% of the circulating supply is burned, your stake now represents 10%.
This can make the token more valuable if a certain feature is tied to it (e.g. governance rights, etc).
3) Selling pressure decreases
As burned tokens can never be sold on the market again, the overall selling pressure decreases. This can have a positive impact on the long term price movement. But, again, there is always a demand side needed.
A token burn model by itself does not guarantee a positive effect on the price, neither in the short nor in the long term.
Disinflationary models such as token burns can contribute positively to the price of a token in the long run, provided there is stable or growing demand. As demand increases, token burns might amplify the price increase over the long run. As demand side decreases, the impact of a token burn tends towards zero.
Lastly, the all important disclaimer: This is my personal opinion. This article is not advice in any way. I don’t recommend to buy, sell or hold any crypto asset. Crypto assets can fluctuate widely in value and all of your capital can be los