Lesson 2 of 30
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2. What is cryptocurrency burning?

It is a process in which tokens (coins) are removed from circulation permanently, ensuring a permanent reduction in supply in the market. How does it work? The coins to be burned are sent to a wallet address, which is only used to receive the coins. That is, no transactions are made on it. It is located outside the network and is intended only to receive cryptocurrencies (tokens) to remove them from the ecosystem. Very often, such a wallet is called a “eater” address. 

Coin Burn is a unique cryptocurrency process; it is the central mechanism of many crypto projects. This process can be seen in particular in the context of ICOs, where unsold coins are destroyed at the end of the ICO.

Coin burning – description of the process 

If you are a cryptocurrency user, you are assigned an address that is used to send and receive coins. All you need is access to the internet to make a transaction.  The same is with your cryptocurrency address. The cryptocurrency network recognizes your wallet address and “allows” you to do business. If this is clear to you, you will easily understand the coin burning process. It happens when the crypto goes to a wallet address that only accepts coins. These wallets, commonly known as burner addresses, do not have their own private keys. Since they don’t have private keys, they don’t have an owner. If the cryptocurrency or token goes to such an address – it is lost forever. Such elimination is traceable on Blockchain.

Reasons for burning cryptocurrencies

You are probably wondering why this whole process occurs. It is to improve the value of assets in circulation. Central banks use the same procedure – they also adjust the amount of currency in circulation to make its purchasing power more flexible. By reducing the number of coins (tokens) of an asset in supply, a given cryptocurrency is supposed to become more valuable and less available for potential buyers.

Some cryptocurrency developers use this procedure for a purpose. There are many other reasons to burn digital assets, but this one is one of the most important. What is interesting – there is no measurable evidence yet that burning an asset actually increases its value. Rather, it is a psychological procedure to act on the mood of investors and users. It is then their behaviour that influences the increase or decrease in the price of a given asset. 

Furthermore, coin destruction is a natural protection mechanism against Distributed Denial of Service ( DDOS ) attacks and spam transactions. Essentially, network users pay a small fee to complete the transaction. Smart contract execution also requires a gas fee on the Ethereum network. Destroying digital currencies is also a similar approach. Instead of paying miners a transaction fee, some projects implement automatic token destruction. As such, a small proportion of transactions are automatically destroyed – Ripple has implemented such a model.

Coin burning, and the Proof – of – burn algorithm

This is one of the consensus algorithms that, in a blockchain network, is responsible for ensuring that all nodes agree on the true state of the blockchain. The mechanism includes multiple protocols that will use validators to agree on the validity of transactions. PoB allows miners to burn virtual currency tokens. Using this algorithm, they receive the right to mine blocks in direct proportion to the coins burned. For miners, the process is the same – they send coins to the address of the burner. This action does not have any impact on the activity and efficiency of the network. It only uses the energy resources needed to mine the coins before burning them. 

Depending on the implementation, the miner burns the native currency or the currency of an alternative chain. In return, he receives a reward in the native coin of the respective blockchain.

The whole process involved in burning coins makes the network agile. Participants get rewards for doing so. Both for burning their coins and the coins of other users of the system. 

Cryptocurrency burning and the balance of crypto mining 

When miners mine a new block, then the rate of coin creation in the Proof – of – work system decreases. This treatment keeps the miners’ activity regular. To mine coins, they have to burn the previous ones. Burning cryptocurrencies is an excellent method to prevent unfair advantages for novice miners. This is why PoB uses a mechanism that even promotes periodic coin burning. All to maintain a balance between novice miners and new users. 

Is burning cryptocurrencies a good thing?

Coin burning is a relatively new approach to cryptocurrency projects. The benefits here are particularly extensive – from environmental protection to increased value. Furthermore, this approach circumvents the Securities Act and maximizes the added value generated for network participants.

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