Both decentralized finance, also known as DeFi, and cryptocurrencies are much newer than traditional finance services. As such, investors are sometimes reluctant to go all-in within the crypto market, creating price volatility. As a countermeasure for price fluctuations, token issuers use buyback and token burns to stabilize the price and adjust the supply and demand dynamics.
What are buyback and burn? That’s what we’re going to talk about in today’s issue of Learn-to-Win.
What’s a buyback, and how does it work in crypto?
Buyback as a concept is nothing new. It’s a simple way to remove digital assets from circulation, thus adjusting both their availability and overall value. Companies have been using stock buybacks for a long time now in traditional markets, to repurchase shares at market price and absorb them. This way, they control the total number of shares available on the stock market at any given time.
In a similar fashion, in digital markets, a token issuer uses buyback to buy a specific amount of cryptocurrency tokens from the open market that he stores in his own wallet. The repurchased coins do not get destroyed, but they don’t reenter the market immediately either. Most of the time, buybacks are applied to increase liquidity and lower price volatility. The rules of supply and demand show us that a lower supply of tokens can stabilize the price long-term, whereas a large amount of available tokens tends to reduce people’s interest in them. Why, you ask? It all revolves around the scarcity principle. The less there is of something, the more we’ll want it.
Burn crypto, burn!
Some people just want to see the world burn. When it comes to crypto, that makes sense because coin burning is a popular way to remove virtual currency tokens from circulation. The burning process entails sending a chunk of cryptocurrency to an unusable wallet address, removing it permanently from the blockchain. This wallet address, known as zero/ burner address / eater address, cannot be assigned to anybody. Once tokens reach the burn address, they are gone and lost forever.
Anyone who owns crypto can burn tokens, but it’s not advisable since it’s the digital equivalent of throwing money on fire. Token issuers are the ones that use this process typically to achieve similar effects to buyback. Through burning, developers can artificially reduce the supply of a token and increase its demand. However, burning does not raise the price of a cryptocurrency token as a buyback does. The value of the cryptocurrency may stay the same even after burning.
As discussed in a previous article, several consensus mechanisms are used to verify transactions on a blockchain. Proof-of-Burn is one of these mechanisms, allowing miners to burn crypto tokens. The more coins they burn, the more rights to write blocks miners get. The problem with PoB is that it reduces the number of miners and the token supply. This leads to centralization as fewer users control the computing power. In order to avoid this type of situation, a decay rate is used, limiting a miner’s capacity to validate transactions via burning.
Most crypto issuers use a combination of these two concepts called “buyback-and-burn.” This process is encoded into smart contracts on a blockchain and gets executed automatically when the required conditions are met. Investors can know for sure that the amount of tokens that leaves circulation never comes back. It’s a foolproof system to achieve steady growth, add value to a specific cryptocurrency, and attract investors.
Now you understand how buyback and burn works and how it affects your crypto assets. The value of your tokens is directly influenced by these processes, either we're talking about burning tokens or buyback.
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