Coin burning is just one of the ways you can earn money in cryptocurrencies. But to understand this term, you first need to know what proof-of-work is. Coin burning, otherwise known as proof-of-burn, is something similar to this.
Proof-of-work
Proof-of-work is a consensus protocol used by Bitcoin and many other cryptocurrencies to validate the transactions that occur in their networks. This protocol is used by miners to confirm transactions and add new blocks to the chain.
This process is known as mining, a term which most will recognise. Many separately-owned nodes make up a blockchain network, and nodes compete among themselves to make sure that the information contained in each block of transactions is accurate. For these efforts, miners receive a reward.
Proof-of-work is essential because it allows for trust in a trustless environment.
What is coin burning?
Coin burning is, as the name suggests, the process of deliberately ‘burning’ and eradicating coins by making them unusable.
Coin burning, also known as proof-of-burn, refers to the sending of coins of native cryptocurrencies to a public address where popular coins can never be spent because the private keys of these addresses are impassable. These addresses are known as eater addresses as they are effectively ‘burning’ the coins sent to them.
This means any coins sent to this address cannot be recovered and so cannot be used again. These coins are then taken out of circulation and are publicly recorded and verifiable on the blockchain. Because they are on the blockchain, there is enough evidence that these coins cannot be utilised.
The main idea behind this is that coin holders can signify their willingness to make losses in the short term. This shows the user is expecting to make more investments in the future.
Reasons for coin burning
You may be wondering why anyone would want to coin burn. Well, there are actually many reasons for doing this.
Increase the value of coins
Coin burning reduces the number of coins in circulation. This makes it an effective way of increasing the coin or token’s value. Economic principles declare that when reducing the quantity of something, it will, in turn, make it much more valuable.
Effective consensus mechanism
Proof-of-burn is an effective way of achieving consensus in a distributed network. It is one of the algorithms implemented by blockchain to gain consensus from all participating nodes on the valid state of the blockchain network.
Sign of long-term commitment
The goal of any cryptocurrency project is to add value to coin holders so they become the core users and supporters of their service. This makes coin burning an efficient tool to signify the long-term commitment of a project. Having a coin burn mechanism to burn excess tokens would go far in bolstering a project’s growth.
It also encourages long-term involvement in projects because the prices will be able to achieve greater stability. This will come from the greater percentage of investors willing to invest in the long term.
There are downfalls…
Along with many things in cryptocurrency, coin burning has its downfalls. One of these is that proof-of-burn involves wasting useful and good resources. Another disadvantage is that this method allows more mining power to go to users who are prepared to burn more money, allowing the rich to get even richer.
Lastly, there is no significant guarantee that a user will be able to recover the whole value of the burned coins, making this method an uncertainty to all users involved. However, as with all forms of money making, it is imperative users do their upmost to research all the advantages and disadvantages so they do not get caught out with this sometimes confusing technology.
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Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.