The Effects of Burning Tokens on a Cryptonomy

burning-tokens

By now most stakeholders in blockchain and cryptocurrency have heard the term “token burning” but what does this actually mean? Tokens are not necessarily destroyed or removed from existence. Tokens that are burned are typically sent to the genesis wallet. The genesis wallet is the very first wallet that is formed when a token is created. The interesting thing about these wallets is that tokens sent there cannot be retrieved. This is why people refer to the process of sending tokens there as “burning.” Some projects even base their entire cryptonomy around this concept and call their model “proof-of-burn.”

The Effects of Burning Tokens

Burning tokens will effectively decrease the total number of tokens in circulation. If you had 1 bitcoin out of 21 million bitcoins, then you have 1/21 million of the total market supply. If, however, 2 million tokens are burned and you have held onto your 1 bitcoin, you now possess 1/19 million of the total market supply. Your “slice of the pie” has now grown. The question is, what deeper effects does this have?

One popular reason for burning tokens is to artificially create scarcity. The thought process is simple – if fewer tokens exist and the demand remains constant, then the value of the tokens must increase. While this is not entirely untrue it also is not the most effective manner of managing unsold tokens. Artificially driving up the value of tokens is seen by many people as a poor and ineffective way to operate because it lacks sustainability. If tokens are continuously removed from the ecosystem the remaining token supply will eventually dwindle to an amount that simply cannot maintain the platform. On another hand, there is also a degree of legal concern regarding this form of cryptonomy. Munchee Inc. is the best example of this to date. The SEC, when investigating Munchee, found that by burning tokens Munchee was trying to promise or guarantee investors an “expectation of obtaining a future profit.”

Alternative Uses for Unsold Tokens

Tokens that remain unsold at the end of an ICO do not have to be burned. There are other methods that are equally as good, or even better, for investors. It is certainly in the best interest of a long-term blockchain venture to avoid the burning of tokens.

One possible solution is to offer the remaining tokens for sale on the website, app, or platform developed by the company. This is a very feasible option for companies who are creating a platform where the tokens play an integral part in the user’s ability to interact with the platform.

Another alternative for this is to distribute the unsold tokens, in equal parts, to investors who purchased the tokens during the sale. For example, if 100 million tokens were created, and 50 million were sold (and 10 million left aside for the core team) then there are 40 million tokens remaining. If George bought 1 million of these tokens (2% of the tokens sold) he would receive an additional 2% of the 40 million unsold tokens ( or 800,000 tokens). This greatly benefits the investor without changing the percentage of the token supply allocated to the team, developers, etc.

While burning tokens might seem attractive in the short term by artificially creating scarcity, it is not always the most appropriate way to manage tokens. Companies should always carefully consider the design of their cryptonomy before launching their ICO.

 

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