Tag: coin burn

London Hard Fork Brings The Burn To Ethereum

The Ethereum network has activated the London Hard Fork successfully (12:34 UTC, Block# 12,965,000, 8/5/2021). In the first two days, $30 Million of ETH (Ether) were burned. That amount of ETH burned, removes approximately 3,000+ ETH from circulation. This is part of the EIP 1559 specification in which a certain portion of the transaction fee is burned per transaction. The hard fork also makes transaction fees on the Ethereum blockchain more predictable. This creates lower gas fees that can bring the costs of transactions down since there is now a base fee.

The introduction of a base fee addresses the volatility in transactions. This is regarding the cost of gas prices during times of network congestion. When the network is at its busiest, the cost of gas can suddenly increase which is why recent transaction costs on the Ethereum network has been high. With a base fee, this can prevent gas prices from suddenly shooting up to levels where it makes more sense to send large transactions than lower ones.

Since Ethereum uses an inflationary currency model, the burning introduces a deflationary system for the first time. This puts a check on the amount of ETH in circulation, which can affect prices to the upside. This has become controversial since it affects miner rewards, but the Ethereum network is moving away from mining (Proof-of-Work) consensus. A protocol difficulty bomb is part of the design for Ethereum 2.0 (ETH2.0) that will make mining more difficult, encouraging validators to move towards staking (Proof-of-Stake) consensus. The London Hard Fork will delay this at the moment to allow time for transition.

In a nutshell the London Hard Fork has enabled the following features:

  • Establish a base fee for transactions
  • Provide more transparency and predictability to transaction fees
  • Make ETH a more deflationary asset with a burning mechanism

Here are other EIPs activated during the London Hard Fork:

EIP 3554 delays the “difficulty bomb”.

EIP 3529 reduces gas refunds. Gas tokens (e.g. Chi) will become obsolete.

EIP 3198 allows users to return the base fee opcode.

EIP 3541 enables future upgrades to the Ethereum Virtual Machine (EVM)

Overall this introduces steps that will bring Ethereum closer to a minerless future. This gives time for miners to transition to staking, but once the difficulty bomb is activated it begins the “Ice Age” for mining. The new structure for transaction fees is also a positive development in light of the skyrocketing costs to run a transaction on the Ethereum blockchain. It doesn’t exactly lower gas prices, but makes it more manageable with a base fee. At least users will not have to deal with sudden increases when all they want to do is transfer ETH to another wallet or swap tokens. ETH will also be headed towards a more deflationary asset as well, with the burning of portions of its transaction fees. All of this creates positive market signals that drives further utility on the Ethereum blockchain.

(Photo Credit by Chris Schippers)

Why Coin Burn Is Important In Tokenomics

The coin burn in cryptoeconomics, is a mechanism that reduces the total supply of tokens or coins. It forms a part of the tokenomic policies of a cryptocurrency. This is for preventing inflation in the ecosystem as a reasonable means to prevent the over supply of the tokens in circulation. It is much more common among coins or tokens that have a high circulating supply or no fixed supply. The amount of tokens in circulation is generally speaking, the total amount that is available to the public. The supply increases as a result of consensus activity that mints or mines more coins or generates new tokens.

There are 3 main reasons for a coin burn.

  1. Minimizing inflation

The traditional non crypto-economic model allows centralized monetary authorities to regulate and control the supply of money. They can increase the money supply during times of low liquidity in order to boost the market. However, more money leads to inflation and that can affect the cost of goods and services as prices increase. More supply leads to more spending power, and thus that increases demand for public consumption. As a result, prices go up.

We have what is called the inflation rate that determines the price or value of any commodity or asset in the market. The problem with inflation is that it leads to ever increasing prices as simplified in this formula:

V = Inflated Value Of Asset
a = Current Value of Asset

r = Annual Rate of Inflation

t = Time period

V = a(1 + r) t

Thus an asset’s value increases over time as a result of a positive (+) inflation rate, which means its value was not determined by market forces but by a central authority. Interest rates tend to rise with inflation. It is a way the central bank encourages people to  increase savings. Now this is a truly centralized approach that becomes a balancing act for the economy. Cryptocurreny will try not to have an inflationary model which is the primary purpose of the coin burn. With this model it gives more value for the holder and prices never drastically increase due to a central authority. Instead it follows a decentralized and market driven approach to keep the supply in check.
 

  1. Fair token distribution

The fairness in token distribution is that the platform does not keep more supply than what should be sustainable for the ecosystem. The community is given the right to vote for a coin burn when it is announced on network during the process of digital governance. This allows token holders to decide whether it is in their community’s best interest. This uses a form of governance token that allow holders to cast their vote. Majority consensus will always win in the ecosystem.

The system can be effective in maintaining the price and rewarding loyal token holders. Thus the distribution of tokens is not manipulated by a single authority that decides over the rest of the token holders. When the decision goes to a vote, it benefits the greater community.

  1. Incentive to holders

The coin burn incentivizes token holders by increasing its value. Let’s say we have the following scenario of a digital asset Y:

Total Supply = 100,000,000
Circulating Supply = 100,000,000

Market Cap = 1,000,000
Price of Y = 0.01

Assuming a user has 10,000 coins, they are valued at 10,000(0.010) = 100.

A coin burn takes place to reduce the circulating supply by 40,000,000.

Total Supply = 100,000,000
Circulating Supply = 60,000,000

Market Cap = 1,000,000
Price of Y = 0.0167

It cuts the circulating supply by 40%. This then changes the price of Y. Assuming a user has 10,000 coins, they are now valued at 10,000(0.0167) = 166.67. This is what creates what is called digital scarcity so that the value increases over time. The value this creates rewards the community for holding the tokens and encourages their participation.

Some networks have to do a balancing act on their token supply if they consider a coin burn. Tron (TRX) has issued their coin burn on what they call Independence Day. The project burned 1 billion TRX after switching over from the Ethereum mainnet to their own mainnet. This also burned the ERC20 tokens that were issued during Tron’s ICO. This was meant to control inflation of the TRX token itself, but increases its value in terms of fiat. Other projects that mint tokens back into circulating supply will have to coordinate coin burns to check their inflation (i.e. anti-inflationary measures). Overall, it should be consensus driven by the community and cannot be decided by the developers or majority token holders alone.