June 10, 2022
Cryptocurrency is an asset that is gaining popularity every day. This class of assets has surged in the last two years. However, price volatility remains high in this digital market, resulting in less investors’ trust.
Token issuers for different blockchain-based projects have adopted two approaches to regulate token circulation and stimulate prices on the market. These cryptocurrency firms use the coin burn and buyback strategy to control the overall supply and value of the coins in circulation. The two approaches, buyback and token burns, often serve a similar purpose — control token emissions and stimulate prices. However, their mechanism and impact on token prices are different. What should you know about token burns and buybacks before investing in the crypto market?
What Is The Coin Burn Approach In Cryptocurrency?
Blockchain engineers use the coin burn strategy to permanently remove a large number of coins from circulation. They take a number of coins and deposit them to a useless wallet address. Blockchain projects render a wallet useless by losing the key, a series of numbers and phrases analogous to the password. Losing the key makes the address unusable, rendering the content inside it worthless. The token sent to the useless wallet is destroyed and removed from circulation.
The tokens deposited in the zero address are either extracted from the existing pool or repurchased from the network’s community. However, issuers do this only if eliminating these tokens from existence impacts the demand and supply dynamics that determine prices. Anyone with a crypto coin can choose to burn it, but remember, you are throwing money away.
Proof-of-Burn (PoB) For Coin Burning
The Proof-of-Burn (PoB) consensus mechanism allows miners to burn cryptocurrency. This mechanism is one of the several consensuses that blockchain networks use to verify the validity of transactions. Besides, PoB allows all the participating nodes to verify the blockchain network’s state after miners burn their virtual currency token. The consensus mechanism involves a collection of protocols. These protocols use several validators to agree on the blockchain network’s legitimate state and validity of coin burn transactions.
Every coin burning transaction is vetted through this mechanism. Blockchain networks use PoB as a Proof-of-Work mechanism to award the right to write blocks (mine). They grant mining rights according to the proportion of coins burned. Miners then move their coins to a burner address. A coin burning procedure uses less energy and resources to keep the network active.
As a result, the number of miners, resources, and tokens on the network reduces. Such a decrease in resources and competition affects the right of validation, which is granted based on the tokens remaining on the blockchain network.
A decrease in the number of miners creates an obvious problem of centralization. Large miners will have a large amount of cryptocurrency to dispose all at once because computing power remains within a small user base. This problem can affect supply and prices if firms with a large capacity to validate a massive number of tokens are allowed to burn it whenever they desire. Fortunately, blockchain networks use the decay rate to control miners’ total capacity to validate transactions. This strategy will enable them to periodically decrease their power to burn a massive amount of coins.
What Is The Buyback Approach In Cryptocurrency?
Token issuers for various blockchain-based projects use buyback to boost prices. The firm can increase the overall value of its token by buying back its crypto assets. This approach allows them to control tokens in circulation.
Buyback is a direct derivation of stock buyback in the financial markets. Companies often absorb shares at the market price to reduce the market’s total shares. The volatility of price dynamics in the cryptocurrency industry drives blockchain-based companies to use a similar strategy to restrict emissions.
A buyback in the cryptocurrency market is when a company uses its resources to repurchase a substantial number of tokens and coins from its holders. The token issuer stores this coin in their wallet. They do not destroy or release them into circulation until they stimulate the market to affect prices. The practice of buyback suits companies seeking to retain the ownership of their token for later use and consequently drive up the value of their coins.
Are Buybacks a Good Strategy?
Blockchain projects choose the buyback approach for many reasons. They may include the need to correct calculation errors that led to the inflation of the number of tokens in circulation or respond to an artificial desire to inflate token prices. Others choose buyback as a way to drive speculation or reorganize allocation. The crypto market widely adopted financial strategies from the traditional market and evolved them to suit decentralized asset needs. The practice of self-investment is one of the conventional financial market strategies that has migrated to the crypto ecosystem. Companies often use self-investment as a staple price stabilization strategy.
Often, the law of demand and supply dictates the need for buybacks. Low token supply in the market can help stabilize the price. Buyback becomes a suitable strategy for lowering price volatility or increasing liquidity.
What Is The Role of Buybacks In The Future of Cryptocurrency?
Buyback is a mirror reflection of what happens in the financial market when companies adjust assets in circulation. Different projects can significantly use the buyback approach to correct market prices if their development teams recognize undervalued assets. Whatever the reason for buybacks, the result will always boost the asset price.
What Does Token Burn Achieve?
Developers often burn a coin to reduce its supply in the cryptocurrency markets. The result of reduced supply impacts the demand for that coin. However, unlike buyback, the scarcity created by token burning does not guarantee an increase in the price of that coin. Sometimes it does not affect the coin’s worth, and many see no benefit in cryptocurrency coin burn.
What Cryptocurrency Coins Can You Burn?
You can burn any coin existing in the cryptocurrency market. All coins can be sent to the burn address whenever the developers want to do away with them or reduce their market circulation. Multiple coins like Stellar (XLM) and Binance Coin (BNB) have used this strategy to reduce the amount of coins in circulation.
What Is the Main Difference Between Buyback and Burning?
Although they work the same way, tokens are permanently destroyed from the market in the case of coin burning. Buyback does not eliminate tokens permanently. Instead, it allows token issuers to adjust the availability of tokens by temporarily putting them in the developer’s wallet.
What Are the Main Applications of Buybacks and Burning in Cryptocurrency?
Coin burning and buyback benefit the issuer in the following four main ways:
Support growth and stability of the token value.
Improve the value of the tokens to attract investors.
Increase token liquidity when the issuer targets low price volatility.
Incentive the issuer’s long-term growth through tokens.
Why is Coin Burning Popular?
The idea of burning became popular in 2017 and 2018 when cryptocurrencies such as Binance Coin, Bitcoin Cash and Stellar adopted this strategy. Newer cryptocurrencies find the approach effective when they want to start cheap. Such token issuers later burn their coins to increase their values once they have enough token holders on their network.
Perception of Buybacks and Burning
Unfortunately, token burning contains a deceptive component because a developer can put tokens in a crypto wallet without losing its key. They can create scarcity by placing tokens in a wallet that investors cannot access or believe is unusable. You must research well on the cryptocurrency project you are investing in or stick to safer investments. Use Rubix to find secure cryptocurrencies and trade today!