What is a Coin Burn? Beginner’s Guide to Proof of Burn

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The Blockchain is the primary database of cryptocurrency that holds all transaction-related information efficiently, verifiably and permanently. It is digitised and decentralised. Once recorded, the data in any given block cannot be changed retroactively without the alteration of all subsequent blocks, which requires the cooperation of the network majority. Blockchain was invented in 2008 by Satoshi Nakamoto.

One of the most regularly followed consensus algorithms includes Proof of Work (POW). The more a miner pays for the computing equipment required to crack the cryptographic puzzle, the better chances there is to score the right to mine the blocks. However, this POW approach is hindered by high power consumption and the need for costly mining hardware devicesProof of Stake (POS) is another algorithm that allots mining rights to the miners proportional to their stakes held in the cryptocurrency.

What is Coin Burn?

Proof of Burn (POB) or cryptocurrency burn stands as a substitute consensus algorithm that tries to address the energy consumption problem of Proof of Work. Proof of Burn is usually referred to as Proof of Work without energy waste. It can also be used to bootstrap one cryptocurrency off another. The central concept behind Proof of Burn is that individuals are expected to burn their coins to mine in a POB consensus protocol. Proof of Burn can also be seen as when a blockchain network applies several consensus mechanism algorithms to ensure that all participating nodes agree about the correct and valid state of the blockchain network thereby avoiding any possibility of cryptocoin double spending. Proof of burn follows the principle of “burning” or “destroying” the coins held by the miners that grant them mining rights.

This can be achieved when miners/individuals send some coins to a verifiably unspendable address, which is also referred to as an “eater address”. This process does not consume many resources other than the burned coins and ensures that the network remains active and agile. Coins sent to the eater address are then taken out of circulation and can no longer be spent. The process of verifying that coins have indeed been sent to an eater address is a very straightforward one, as all POB transactions are duly recorded on the blockchain. Once it is shown that these coins can no longer be used, users are then rewarded. Ian Stewart is the inventor of the Proof of Burn algorithm.

Reason for Cryptocurrency Coin Burns

The idea behind the Proof of Burn technique is that users are willing to undergo a short-term loss for long-term investment by burning a cryptocurrency. Users are usually rewarded over time, and they earn a lifetime privilege to mine on the system. The user stands a greater chance of mining the next block when the individual burns more coins.

The eater address is an address that is used to store burnt coins that are unusable and unspendable. While most public addresses are generated from a private key that grants the holder access to any coin sent to that address, the case is entirely different of eater address. The eater address is randomly generated and does not have a private key. When there is no private key or no way to generate one from a public address, coins sent to the eater address can never be accessed or spent.

There are, however, various reasons why cryptocurrency is burned.

Long-Term Commitment

One reason why coins are burned is that encourages a long-term commitment and time of a project. This enables greater price stability for the coin because long-term investors are unlikely to sell or spend their coins.

Getting Rid of Unsold Coins

During the ICO sales, the number of coins to be sold are usually already determined. The remaining ICO coins that are not sold sometimes end up in the wallets of the companies. These unused coins end up as free money for the company, as the value of the coin has gone up because of the ICO. They sell these remaining coins on the market and make a profit.

However, some companies do not just keep their unused coins to sell them, but instead burn them. An example of such company is Neblio. After their ICO, they promised to burn all of their unsold coins, and they kept to their promise. This way, only the value received from the actual sale was used to develop their blockchain application.

Paying for Transaction Fees

Another reason why proof of burn occurs is that it can be used to pay for transaction fees. Ripple, the currency exchange and remittance network that uses this method. For every Ripple transaction, a minor amount of that transaction is burned. By doing this, the user pays for the transaction and the Ripple network benefits immensely from the usage of Ripple, because there is less and less of their cryptos in circulation, which eventually drives the price up.

Another payment cryptocurrency which uses burns on transaction fees is Request Network, their REQ tokens are burned with each transaction on the network. You can view a real-time count of the token burns here.

REQ Burn

Another coin which is burned regularly is the BNB Coin, token of the Binance Exchange. Binance will use 20 percent of the exchange’s profits every quarter to buy back and then burn BNB. It will continue this process until the supply of BNB is 50 percent of the original amount, with 100 million BNB remaining.

Proving the Process

Cryptocurrencies to be burned are usually sent to an address that is verifiable, invalid, unspendable, and which cannot be accessed or used. By doing this, the cryptocurrencies are taken out of circulation entirely, because they cannot be used anymore. This address cannot be accessed for trade. To show investors evidence that these cryptocurrencies have been burned, a method called “Proof of Burn” was developed. This method uses the same logic as the blockchain technology, which means that trust has been established without a third party to verify actions and transactions. Proof of Burn provides empirical and untampered evidence showing thaw cryptocurrencies have been burned.

Justifying New Coin Creation

Another reason why cryptocurrencies are burned is that a newly created token actually has value because of it. When developers create cryptocurrency, interested parties invest by sending bitcoins, and the investments received are either stored or sold by the developers. The cryptocurrency the investors receive now has value because of the demand, and a similar value is transferred to the developers.

Counterparty used this tactic during their somewhat unique ICO. The developers of Counterparty created an unspendable or unusable Bitcoin address to which you could send your bitcoin to invest in the ICO. Instead of claiming the received Bitcoins themselves, the received bitcoins can never be used again. The address and the burning process were completely transparent and visible online. The burning was done using the Proof of Burn method.

Proof of Burn vs Proof of Work vs Proof of Stake

Digital currencies like Bitcoin and Ethereum are successful today because of two computer algorithm is known as Proof of Work and Proof of Stake. Cryptocurrencies as a whole are successful because of these algorithms. Proof of Work is by far, the most commonly used protocol, which enables users to generate new coins by mining. Proof of Stake, on the other hand, is also quite popular, as it allows users earn interest for keeping their funds in their wallets.

Proof of Work (POW)

In the cryptocurrency scene, Proof of Work is the most commonly used protocol which allows users mine their currency. It is used by digital currencies to reach an agreement or rather a decentralized agreement around a particular block unto the blockchain. With Proof of Work, miners compete against each other to complete transactions on the network and get rewarded. Hashcash (SHA-256) is the Proof of Work function that is used by Bitcoin miners to solve computationally complicated math problems to add blocks onto the blockchain.

Bitcoin Mining

In a network, users send each other digital tokens with a decentralized ledger gathering all transactions into blocks. This responsibility is carried out by specific nodes known as “miners” and the process is called “mining”. Proof of Work is time-consuming and computationally expensive, and the process is very intensive. In the Bitcoin world, Proof of Work is the only protocol that will be used, based on the current database. Other cryptocurrencies, however, use a combination of Proof of Work and Proof of Stake.

Proof of Stake (POS)

Proof of Stake is an alternative to reach an agreement or decentralized consensus. Due to the time, too much and energy and electricity, and high cost that Proof of Work required, it was suggested that Proof of Stake be used, as miners felt that mining a single block was a waste of resources. It involves users who stake their cryptocurrency wallet balance. Not every cryptocurrency supports the Proof of Stake, but it is prevalent among some altcoins. As against the Proof of Work, the Proof of Stake is more  environmentally friendly and provides rewards for the holders.

Proof of Stake

In Proof of Stake, the number of coins in a user’s wallet matters. The more significant your stake, the higher your chances of not breaching the system. People who own a substantial percentage of the total coin supply will earn more stakes. Depending on the cryptocurrency in use, the Proof of Stake rewards may cause inflation. Some cryptos, however, which use Proof of Stake from the beginning, have steady supplies at all times.

Proof of Burn differs from Proof of Work and Proof Stake in the sense that Proof of Burn addresses the energy problem of Proof of Work and coins are sent to a verifiably unusable address where coins are burned, and the value of the coins increase.

Cryptocurrencies Using Proof of Burn

Several coins are beginning to adopt Proof of Burn, as it is becoming increasingly popular as a choice of a consensus protocol. Probably the best-known example of a Proof of Burn coin is Counterparty (XCP), which uses Proof of Burn to seed its tokens. Bitcoins are sent to an unspendable address, and users receive Counterparty tokens in return. There are others such as Slimcoin (SLM), which burns coins as a mining method and consensus mechanism, and Triggers (TRIG), which is based on the Counterparty protocol.

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Priyeshu Garg is a software engineer at a unicorn, while he is not solving complex programming problems - he writes about blockchain and trades cryptocurrencies.

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