Before diving into the various burn models that are out there, let's first address a few core topics that are essential to review. These points will serve as a foundation for our discussion on various burning mechanisms.
Economic Factors
In theory, decreasing the supply of tokens should increase their value, as long as there is sufficient demand. However, a token burn might not have an immediate impact on the price. This brings up an important question:
Have you explored other ways to use tokens within your project's ecosystem, or is a burn mechanism the most effective growth strategy?
A price increase is linked to additional market demand, but reducing supply might not always be helpful, depending on the token's role in the ecosystem. The economic value that is destroyed could be put to better use:
- Incentivization
- Distributing tokens to current holders through staking incentives, airdrops, etc.
- Rewarding users for positive behavior, such as liquidity provision or lending incentives
- Establishing an ecosystem fund or developer grants platform
- Supporting community initiatives, like support or marketing DAOs
Essentially, it's crucial to weigh the potential price impact against redirecting economic resources for growth without relying on additional token inflation.
Consequences on the Token Distribution
Burning more tokens affects their distribution among current holders, which is often overlooked. Large-scale token burns can significantly impact the carefully constructed tokenomics of a project.
Removing a portion of the token allocation might endanger a well-designed power structure, even though token holders and community members might view the burn positively in the short term. A protocol token, especially one with governance rights, is meant to decentralize decision-making. As such, it's important to consider any hidden effects and review them carefully:
Does the burn mechanism have any significant or hidden effects on the intended distribution of token ownership?
Narrative Implications
While not directly related to the token economy, burns have proven to be an effective marketing tool, sparking user interest on social media platforms.
Typically, projects publicize their token burn events to attract investor attention. The rationale is simple: The burning mechanism convinces investors of the long-term value increase. It’s interesting to note that the psychological impact seems to work regardless of how the burn mechanism affects the token supply. ¹
It's essential to understand the impact on your audience while managing long-term price expectations. Unfortunately, the psychological effect has been frequently misused by fraudulent projects. As a result, communication efforts surrounding the burn must be carefully reviewed and orchestrated to create a healthy level of expectation. The key question to answer is:
Does the burn mechanism align with both the project's narrative goals and the community's sentiment?
In the next section, we’ll go over the various burn models that exist and explore a few examples.