With a solid understanding of the key burn considerations, let's examine various burn mechanisms that have emerged in the crypto landscape. These range from automatic burns triggered by chain transactions to community-led manual burns. In this section, we'll explore six types of burn mechanisms through examples: Transactional Burns, Event Burns, Governance Burns, Auction Burns, Goodwill Burns, and Algorithmic Burns.
Transactional Burns are burning mechanisms automatically triggered when a transaction is created on the blockchain. A certain portion of the fees captured within the transaction is burned.
- Mechanism: Transactional Burn
- Activation Method: Automatic
- Frequency: Constant
- Token Source: Transaction Fees
The most notable examples of Transactional Burns are the EIP-1559 upgrade on Ethereum and the BEP 95 upgrade on the Binance Smart Chain (BSC).
Ethereum Improvement Proposal 1559 (EIP-1559) introduced a new mechanism to burn a portion of the transaction fees to compensate for the inflationary nature of ETH issuance. The former auction method where users bid with gas for their transaction was replaced by an algorithmic process that sets an overall market rate for gas fees called base fee. The base fee fluctuates depending on network activity, keeping the average gas fee around the same range and being burned.
While the burn of the base fee effectively started reducing the circulating supply of ETH, it didn't cause a deflationary effect due to the high mining rewards when Ethereum was running on Proof-of-Work (PoW). However, the economics of the network changed after "the Merge" when it switched to Proof-of-Stake (PoS). On PoS, the issuance rate of ETH per block dropped significantly, leading to an actual occasion for the base fee burn to outpace the block rewards paid to validators.
The success of the burn can be attributed to two factors. First, it created a positive feedback loop via network usage, benefiting all ETH token holders from interacting with the chain instead of increasing validator revenue per block. Secondly, instead of merely adding a simple burn mechanism to burn ETH, the newly introduced base fee improved the fee. Consequently, the burn appears as a natural mechanism that doesn't negatively impact the economic activity on-chain.
Additionally, the burn helped shape a narrative around the ultra-sound money movement for Ethereum. Even though the burn is now outpacing daily native ETH inflation, it's essential to note that without the burn, a deflationary effect could not have been achieved at all. More data insights on the deflationary effect can be found here.
Key takeaways from Ethereum EIP 1559 Transactional Burns: ► Activity Feedback Loop: Connecting a burn mechanism to the economic activity on-chain creates a positive feedback loop. ► Meaningful Improvement: Burn mechanisms work best in combination with a systemic improvement, giving the burn a purpose beyond value destruction (fee adjustment). ► Narrative Enabler: Burn mechanisms can thrive in isolation as a narrative, but they become truly successful when embedded in a compelling story that serves a purpose beyond price increase that the community can pick up.
In comparison, the Binance Smart Chain implemented two different burn mechanisms for the chain's native fee token BNB: "Real-Time Burn" and "Quarterly Auto-Burn."
The "Real-Time Burn" mechanism was introduced in November 2021 through the Binance Evolution Proposal (BEP) 95. It allows the smart contract to automatically burn a portion of the gas fees collected by validators from each block. Unlike Ethereum, the Binance Smart Chain has no inflationary block rewards. Thus, validators depend on generating revenue solely from capturing transaction fees and commissions.
With BEP 95, a fixed ratio of the gas fee collected by validators is burned in each block. Initially, the ratio, governed by validators, was set to 10%. There is no technical need for the burn mechanism other than validators, and ultimately, the stakers, accepting to reduce the total supply of BNB instead of taking the revenue.
Besides the "Real-Time Burn," Binance introduced the "Quarterly Auto-Burn." Previously, the quarterly BNB burns were based on the trading volume on the Binance exchange. In December 2021, Binance announced that the new "Quarterly Auto-Burn" would replace the manual burn. The tokens are provided by Binance. The burn amount follows a formula based on the BNB price (P), the number of blocks generated per quarter (N), and a constant price anchor (K), which is initially set at 1000: Burn = ((N x 1000)/(P+K)). Thus, a lower price of BNB leads to a higher burn.
Unlike the ultra-sound money movement on Ethereum, both burn mechanisms for BNB serve the same purpose: accelerating the process of burning BNB tokens (with a goal of 100 million BNB, or 50% of the initial supply). The "Quarterly Auto-Burn" will end at the 100 million BNB mark, while the burn introduced through BEP 95 will continue beyond that point. Binance focuses strongly on the deflationary narrative for BNB and heavily promotes burns on social media channels. Data on how many BNB tokens have been burned can be found here.
Key takeaways from Binance BEP 95 Transactional Burns: ► Repeating Events for Narrative Impact: Having multiple structured burning mechanisms on-chain helps focus the narrative on long-term price effects. Specifically, large one-time events generate attention. ► Governance Integration: Easy-to-understand burning parameters can generate community engagement. ► Natural Integration: A burn mechanism works best if it is integrated into the given processes, such as the transaction fee. The fee amount to pay remains unchanged for the user.
Auction Burns introduce a mechanism that burns tokens through an auction for fees captured on-chain. Auction Burns can be seen as an extended version of Transaction Burns, incorporating community participation to benefit from fee collection.
- Mechanism: Auction Burn
- Activation Method: Automatically, Manually, or Event-based
- Frequency: Periodically
- Token Source: Transaction or Protocol Fees
Some examples of Auction Burns are the Injective Burn Auction and the MakerDAO Surplus Auctions.
The Injective Network has a unique fee-sharing mechanism that divides the fees generated on-chain into two pools. 60% of the fees are allocated to an on-chain buy-back-and-burn auction conducted weekly, while 40% go into a developer funding pool.
During the weekly on-chain auction, users bid on the fees accrued by the network using INJ, the native fee token of the Injective Network. The expectation is that INJ token holders can bid on the generated fees at a discount. The INJ bid is immediately burned, and a new auction period begins as soon as the burn is completed.
The burning mechanism resembles Ethereum's EIP-1559 Transactional Burn model, but adds an auction component. Although the inflationary emissions of the Injective network currently surpass the burn, community members who support and hold INJ can capitalize on the long-term effect by speculating on INJ twice. First, they can buy INJ upfront and acquire additional assets at a discount on their INJ. Excluding an out-of-order burn of 5M INJ, around 650k INJ has been burned within 14 months of the initial 100M token genesis, counteracting the additional native yearly inflation of around 9%. ¹
Another similar auction model can be found in the MakerDAO ecosystem. The dollar-pegged stablecoin DAI is minted against a dynamic system of vaults. The protocol charges a stability fee for borrowing DAI against the vaults. When the net surplus from stability fees reaches a specific limit, an auction is conducted, where actors can bid in the protocol token MKR at a discount on DAI. The MKR token of the winning bid is burned in these so-called Surplus Auctions. So far, 22.4k MKR tokens have been burned from the initial finite supply of 1M tokens, reducing the supply by 2.24%. ²
Key Takeaways for Auction Burns: ► Community Triggered Burns: Burns can benefit the community twice by auctioning accrued fees against protocol tokens. By doing so, additional opportunities can be created to engage community members.
Event Burns are methods for burning tokens by triggering specific on-chain events. Event Burns can be layered on top of Transactional Burns. Three parameters need to be defined: The event initiating the burn, the payment amount for the event, and the percentage of destroyed tokens.
- Mechanism: Event Burn
- Activation Method: Automatically
- Frequency: Constantly
- Token Source : Point of Sale Protocol Revenue
As one of the top decentralized exchanges (DEX) on the Binance Smart Chain, PancakeSwap has faced criticism for the inflationary tokenomics of its protocol token CAKE. Consequently, PancakeSwap incorporated various burn mechanisms for trading and interacting with features such as prediction markets to address these concerns.
In addition to transactional burns, PancakeSwap imposes fees for activating certain functionalities, such as creating a profile or buying lottery tickets. For example, in the personalized profile feature, users share their personality via NFTs and qualify to join leaderboards and events. All the fees paid by users in CAKE are burned.
Event burns function in an environment that can be used as gated access for social features, closer to classic product sales. Burning the price for social features can be a win-win scenario, as every profile owner contributes to the tokenomics by not only burning the token but also receiving a kind of badge in the form of a profile for PancakeSwap.
As of February 2023, over 700k active members have joined a team with their profile, burning over 1M tokens of the now newly integrated maximum CAKE supply of 750M, with a circulating supply of around 166M. ³ ⁴
Key takeaways from Pancake Swap Profile Event Burn: ► Product Sales Replacements: Burns can be seen as a web3 version of modern product sales, as the value spent is destroyed. ► Staggering Burns: Single events integrated within the ecosystem can be used to stagger multiple burning events on top of each other for a cohesive narrative.
Governance Burns involve a project contributor or community member proposing a one-time token burn event. These burns can target dormant token allocations or fee-accruing mechanisms within the protocol. The reasons for the burn can range from general narrative to structural tokenomics ideas.
- Mechanism: Governance Burn
- Activation Method: Manually
- Frequency: One-Time Events
- Token Source : Various Sources
Bancor and Kujira provide two examples of one-time governance-driven token burn events.
Bancor voted on a proposal to burn part of the protocol's BNT token to test if a deflationary narrative truly supports the token price. The proposal argued that "[…] community sentiment supports burning BNT as a trial to see if it will have a positive impact. DAO members have cited the psychological effect of ‘burns’ on market participants and believe a similar effect could occur through this experiment. […]". ⁵
The proposal aimed to burn 1 million BNT accumulated in the Bancor V3 vault. Days after the vote passed, 1M tokens were destroyed, burning around 0.5% of the circulating supply. Unexpectedly, the token destruction had no short- or mid-term effect on the tokens' price, falling from around $0.45 to $0.35 over the next four months. It's worth noting that the token burn occurred weeks before the FTX crash.
In contrast, the Kujira team proposed burning tokens allocated to liquidity mining and staking rewards to align with the protocol's focus on sustainable real-yield generation.
The team criticized the unsustainable liquidity attraction scheme of automated market makers (AMMs) and identified the reward allocation as an unnecessary inflationary mechanic. The hypothesis, formulated in a voted governance proposal, stated that the tokens put selling pressure on the market. On-chain data supported this hypothesis, as nearly 40% of the rewards had been sold daily since incentivizing liquidity pairs with their KUJI token. ⁶
Following the governance decision, around 23M KUJI were burned from a planned airdrop, staking rewards, and marketing allocations. The destruction resulted in a 15% reduction of the initial token supply of 150M $KUJI, significantly impacting the overall token allocation but not the price. While the burn positively impacted token holders' dilution at the time, it also considerably shifted the planned distribution.
Key takeaways from Governance Burns: ► Community-Driven Burns: If put to a vote, the community is likely to support token burns. ► Questionable Effects: Large token burns significantly affect the overall token allocation. Redirecting tokens might be an alternative solution for one-time burn events. In other words, one-time token burns don't necessarily have the same impact, price effect, or narrative effect as constant burn efforts.
Goodwill Burns occur when community members voluntarily destroy their personal holdings without receiving a return or new minted assets. Goodwill burns are often crucial in memecoin communities and should be understood as a narrative that encourages token holders to burn their private holdings.
- Mechanism: Goodwill Burn
- Activation Method: Manually by third-parties
- Frequency: Random
- Token Source: Private token holdings
Shiba Inu is a well-known example of a vibrant memecoin community focused on burning events conducted by community members. As stated on the ShibaSwap burn page, the community views burning as a core feature, almost like a rite of passage to gain membership in the community. ⁷ The act of burning takes on a nearly religious significance and is not easily explained through logic. Similar sentiments have been observed lately within other communities, such as LUNC/Luna Classic.
The psychological effect is driven primarily by the massive number of tokens that have been burned, implying extraordinary success of community efforts. However, the numbers are not significant in value due to the high supply of memecoins. According to the Shiba Burn Tracker, 83 billion Shiba Inu tokens were burned throughout 2022, only 0.015% of the total supply. Nonetheless, the burn narrative has proven successful on social media platforms but should be approached with caution in terms of long-term success and sustainability.
Another method for Goodwill Burns can be found in the NFT scene, where artist Pak created a platform called burn.art, which allows users to burn NFTs in exchange for ASH. The concept behind the platform is to add fungible possibilities to NFTs, allowing collectors to determine the value of the art and the tokens. Additionally, the ASH tokens themselves serve as a medium of exchange on the burn.art platform, enabling users to buy and sell digital assets. The burn creates a unique case study for creative tokenomics, creating a gamified economic system closer to video game economics. Like memecoin communities, there is no way to predict the burn or establish a sustainable process around it.
Key Takeaways from Goodwill Burns: ► Burning for Community Building: Burning has been used by many projects and communities to find common ground. The potential financial upside in burning has proven to be a powerful marketing tool but lacks sustainability. ► Creation Through Destruction: Burn mechanisms can be connected to the minting of new assets, building a new ecosystem driven by community sentiment.
Algorithmic Burns involve altering the available token supply through specific rules as part of stability mechanisms.
- Mechanism: Algorithmic Burn
- Activation Method: Automatically
- Frequency: Random or Rule-based
- Token Source : Various
It is worth noting that this type of destruction mechanism differs slightly from other burn methods mentioned earlier, as the destroyed tokens may be reminted at a later stage.
As a result, Algorithmic Burns are commonly used for experimental stablecoin projects, leveraging the method of "rebasing" or "seigniorage shares" to create a peg mechanism. The best-known examples are OlympusDAO's OHM token for rebasing and Terra's former stablecoin UST for seigniorage shares.
In short for rebasing: The OlympusDAO protocol adjusts the circulating OHM supply to loosely control the token value. For example, if the price of OHM drops below a certain point (the value of 1 DAI), the algorithm automatically burns OHM supply to maintain a minimum price. Conversely, if the price exceeds this level, new tokens will be minted and added to the supply to stabilize the token value. In this case, the burn is almost a protection mechanism for OHM holders.
In short for seigniorage: In this model, a combination of protocol-based mint-and-burns and free market mechanisms arbitrage opportunity act as a stability device. The stable token is held onto its value via a second volatility absorber. The Terra ecosystem is a widely known example introducing the dollar-pegged stablecoin UST and the volatility absorber (seignorage share) LUNA as the native chain token of the Terra ecosystem. If the UST stablecoin's price climbs over $1 due to investor demand, $1 worth of LUNA can be burned for 1 UST, creating an arbitrage opportunity for UST. The algorithm ensures a swap of the current dollar value in LUNA to UST and vice versa.
In this scenario, growth of UST creates a deflationary system for the volatility absorber LUNA. Consequently, a solid community-driven burning narrative was designed around UST's mint for additional LUNA burns. Due to the downfall of the Terra ecosystem, seigniorage-driven stablecoin models currently need to be seen as a viable solution. In terms of the burning mechanism, it can be taken as a reference for experimental stability mechanisms.
Key Takeaway from Algorithmic Burns: ► Innovative Stability Mechanics: Burn and Mint mechanics might serve as experimental technologies to create innovative stability mechanisms.
Token burning mechanisms can have a variety of purposes, ranging from supporting token value to community building and stability mechanics. Different projects use different strategies, and the effects of token burns vary from case to case. It is essential to understand the underlying reasons and mechanics for each token burn to make informed decisions on the potential impact on a project or token's value. However, one should always keep in mind that burning tokens may not guarantee success or sustainability for a project or token in the long run.
In the next section we cover the key takeaways on burning mechanics