November 14, 2018 Knowledge Center

All You Need to Know About Coin Burn

Coin burn, also called proof of burn, is the process of putting a portion of cryptocurrency in a wallet address and recorded in the blockchain where the private key is unobtainable. As a result, it cannot be accessed by anyone, thus rendering the coins useless or burning them.

One of the tools used in coin burn is the eater address: the actual valid address users use when they trade. These addresses are randomly generated and cannot be reused by anyone again.

Why Is There Coin Burn?

Coin burn is primarily done to create new coins, to reward the coin holders, and to destroy any coins that hadn’t been sold after a coin sale.

Is it legal?

Yes. In a way, coin burn or proof of burn is also proof that the user is willing to incur losses in the short term because he is looking forward to bigger and better returns in the future. Furthermore, the more coins a user burns, the more likely he is to mine the next block.

Creating New Coins

There are specific cryptocurrencies, like the Counterparty (XCP), which cannot be mined or sold in an ICO. Instead, they are created by burning bitcoins, and once the bitcoin is burned, XCP coins are generated on the blockchain. The created XCP coins gain value because the burned bitcoins cannot be used again.

Rewarding Coin Holders

This situation – rewarding the coin holders – uses the law of supply and demand – when there is little supply and more demand, the value of the product increases.

In the United States and some other countries, rewarding token holders with different cryptos as direct dividends is not allowed. In such cases, companies burn coins to create a scarcity of supply; thus, the value of the currency their investors are holding increases.

Destroying Unsold Coins After a Sale

Sometimes, not all coins are bought during a sale. These unsold coins give the company an unfair advantage because they (the company) can sell these coins in the free market at a higher price. Therefore, they have to burn these unsold coins to exercise fairness and transparency.

Differences Between Proof of Burn, Proof of Work, and Proof of Stake

Aside from proof of burn, there is also proof of work and proof of stake.

What are they? Are they similar to the proof of burn?

Proof of Work

Proof of work is a computer algorithm used by several cryptocurrencies including bitcoin and Ethereum. It is used to come to a consensus when to add another block to a blockchain.

Mining for cryptos needs a lot of effort, hardware, and computational power before the miners solve a block. During the mining process, the miners need to solve complex mathematical equations before they can validate each transaction. Every single transaction can use up to 300 kWh, which is enough electricity to power up one household for a month. One study even revealed that the bitcoin network uses as much energy every year as Ireland.

Proof of Stake

Proof of stake was created as an alternative to proof of work.  Many users and companies alike agree that proof of work is not only time-consuming but it is not user-friendly as well because of the amount of effort and electricity it consumes.

As opposed to PoW, proof of stake it uses the coins the owner has as proof instead of the work he has accomplished. It works on the principle that if someone has invested more coins (stake), the less likely he will breach the system because he will have to protect his investment.

In this arrangement, coins are minted rather than mined or forged. Users who have large coin holdings in the system are randomly selected for minting and then adding more blocks in the blockchain.