Read on to understand what buyback and burn mean in the world of cryptocurrencies and learn how this strategy actually works.
A crypto buyback and crypto burn is a great way to reduce the overall supply of any cryptocurrency.
The buyback and cryptocurrency burning process has the potential to increase demand for a particular token and stabilize its price.
Crypto investors should consider some risks associated with this investment strategy before implementing it.
In the traditional financial market, self-investing has been a staple instrument of price stabilization for companies. The cryptocurrency market largely grew as a result of migrating and adopting financial strategies from the traditional market to suit the needs of decentralized assets. So it becomes necessary to understand crypto buyback and crypto burn.
Cryptocurrencies have experienced the turbulence of price dynamics as well as increasing competition with other tokens circulating on the market. This is one of the reasons blockchain-based projects have started applying two types of approaches to stimulate prices and control their emissions – buybacks and token burns. While both concepts serve the same purpose, they differ when it comes to their mechanisms and goals in terms of price influence.
What is a crypto buyback and crypto burn?
The concept of crypto buyback and cryptocurrency burn refers to the practice of companies buying back their tokens from the market and subsequently destroying them. This is done to reduce the total number of tokens in circulation and positively impacts the price of the tokens. In other words, this practice is a way to increase the value of a particular token. Token holders get to see the value of their tokens increase, which means it’s beneficial for all the parties involved.
One of the first adopters of this strategy was Binance, one of the largest cryptocurrency exchanges. It used almost 20% of its profits to buy back and burn Binance Coin (BNB) tokens. This resulted in an increase in the price of BNB tokens and the value of the company as a whole.
The practice has since been adopted by other exchanges including Huobi, OKEx and Kucoin. All of these companies had positive results after implementing their own buyback and burn programs.
How does the buybacks and burn process work?
One of the several consensus mechanisms that blockchain networks use to verify transactions is Proof-of-burn. It is a proof-of-work protocol that does not waste energy, instead allowing miners to burn tokens of virtual currency. The protocol then awards the right to mine in proportion to the coins burned.
Miners then transmit the coins to a burner address and destroy them. Apart from the energy used to mine the coins before burning them, the procedure uses fewer resources which keeps the network active and flexible. Depending on how the process is implemented, you can burn either the native currency or tokens belonging to an alternative chain, such as BTC. In exchange, you get a payout in the native currency.
However, the proof-of-burn protocol also reduces the number of miners along with the token supply as there are fewer resources and less competition. This can grant too much capacity to large miners which allows them to burn massive amounts of tokens at once, which affects price and supply.
To get around this problem of centralization, a decay rate is frequently utilized. This effectively decreases individual miners’ total capacity to validate transactions. Proof-of-burn is similar to proof-of-stake as miners need to lock up their assets to mine in both cases. However, stakers can get their coins back after they are done mining with proof-of-stake, which is not possible in proof-of-burn.
In the context of cryptocurrencies, the buyback works the same way. It involves purchasing tokens from the community and putting them in the developer’s wallets. It does not permanently eliminate the tokens, unlike coin burning.
Advantages of buyback and burn in cryptocurrencies
The cryptocurrency market experiences higher price volatility than traditional markets, at least in the current market environment. The crypto market is still in its infancy which results in lower investor confidence. Thus issuers need to formulate a clear, functional, profitable and stable value proposition to attract investors.
How Crypto Buyback and Crypto Burn Impacts Crypto Price?
These programs support the growth and price stability of the token’s value once it is available for secondary trading.
They make tokens more attractive to investors.
Buyback and burn programs result in increased liquidity as secondary market demand is always higher. This results in lower price volatility for the token.
Buyback and burn programs encourage long-term growth investors to HODL the token which makes its price more stable.
Risks associated with Buyback and burn
The crypto buyback and cryptocurrency burn strategy entails some risks. One risk is that the issuing company doing the buyback removes too many tokens from circulation. As a result, any crypto dApp which relies on the particular token may “run out of fuel”.
There is also always the risk that the value of the token might fall after the buyback. If this happens, investors are left with less value than before. This normally occurs when a team performs a buyback which is lower in amount than anticipated.
However, both the risks mentioned above are relatively low compared to the rewards that this strategy produces.
Buyback and burn as a de facto standard in crypto
The major difference between crypto buyback-and-burns and stock buybacks or dividend buybacks is that the former is guaranteed and automatic. In the case of buying a traditional stock, investors are unaware whether the company will pay dividends or buy back stocks in the future. This decision is up to corporate decision-makers. However, in the case of buyback-and-burn, pre-defined encoded smart contracts execute the process. This means the issuer has no choice but to follow through on promises. All of this points towards buyback-and-burn strategies becoming the de facto standard for digital currencies in the future.
With the buyback-and-burn strategy, companies cannot tamper with the rules. Investors can also ask for proof that the token burn has happened. Thus, the process eliminates uncertainty on the side of the investor and does wonders for price stability and long-term value growth.
This article has been originally published at: https://coingape.com/education/what-is-crypto-burn-and-crypto-buyback-does-it-increase-crypto-price/