【Special Feature】Token Burn: Marketing Gimmick or Economic Logic?

In the token economy of platform tokens, there will always be a "token burn" deflation mechanism involved. Some people's immediate reaction upon hearing this term might be, "If tokens are going to be burned, why issue so many in the first place?" or "This is just a marketing tactic by the exchange." In this article today, we will help everyone understand the design thinking behind the token burn mechanism of platform tokens and its significance.

Is Token Burning a Marketing Tactic?

Friends who invest in platform tokens must have come across the term "Token Burning." Token burning refers to the practice where cryptocurrency exchanges reduce the token supply in the market by destroying tokens, thereby driving up the long-term value of the tokens. (Note: Platform tokens are cryptocurrencies issued by exchanges for purposes such as offsetting trading fees, voting, and lucky draws.)

Some might intuitively ask, "If they are going to burn tokens, why did they issue so many in the first place?"

In fact, there are various interpretations of token burning. From a marketing perspective of exchanges, token burning, like the Bitcoin halving, is a positive topic. When the news of token burning is released, it can create "legitimacy" for the token price increase in the market, attracting investors. For example, in February this year, the cryptocurrency exchange OKEx announced the burning of 700 million OKB (OKEx platform token) held by the team, resulting in a more than 30% surge in the token price on the same day, a typical example.

However, under the law of supply and demand, even with a reduced supply, the importance of demand cannot be ignored. If an exchange cannot maintain or increase the unique demand for tokens after burning them, the potential value of the tokens may not truly increase steadily. Furthermore, reducing the supply will only stimulate "short-term speculative demand," while "long-term user demand" may not grow accordingly. In other words, the fact that token burning drives a long-term token price increase must be based on the premise of the platform's stable growth to be realized.

Token Burning as a Commitment and Reward to Investors

Looking at it from the perspective of the long-term development of exchanges, token burning is a very effective operational method. Many tokens in the market were issued through ICOs in 2017-2018. During that time, project parties would raise operational funds by selling tokens.

From the perspective of investors, investment is for profit. Taking platform tokens as an example, if an exchange's success cannot be linked to the value of the platform token, the investment becomes meaningless. However, if platform tokens directly represent equity or profit-sharing, it will be classified as securities by regulatory authorities, and the exchange will face endless legal battles. No one would be foolish enough to invite trouble voluntarily.

Therefore, to attract investors to participate in fundraising, promising to burn platform tokens regularly in proportion to the exchange's profits is the best way for exchanges to reward investors while avoiding regulatory issues. At the same time, in order to achieve higher returns, investors will use their resources to support the exchange, bringing mutual benefits to both parties.

On the contrary, if an exchange only issues a small number of tokens from the beginning, it will not only fail to raise enough operational funds but also discourage investors from participating in fundraising.

Is Burning Tokens Circulating in the Market Meaningful?

The way token burning is implemented has become a hot topic in the market.

In 2019, the co-founder of Binance, He Yi, and the founder of Huobi, Li Lin, once argued about this. In July 2019, Binance announced during the 8th BNB (Binance platform token) quarterly burn that from then on, the burned tokens would not be repurchased from the market but from the team's holdings (the team holds 80 million BNB, unlocked in five installments over four years), until one billion BNB is burned.

At that time, Huobi's founder Li Lin questioned Binance's approach as a disguised cash-out:

"It means, regardless of circulation, directly burning from the team's holdings, meaning no need for repurchase, directly deducting from the reserved. If everyone thinks this plan is good, great. The cost of repurchase is reduced by hundreds of millions each quarter."

In response to various criticisms, He Yi provided multiple responses on Weibo, stating that the amount burned still accounts for 20% of profits, and burning the team's BNB resolved concerns about team selling in the market. This 20% profit will continue to be invested in the Binance ecosystem, not for personal gain.

So, is there a difference between burning tokens from the team or repurchasing from the market? The short-term impact may vary, but in the long run, there is not much difference. Some believe that burning team tokens has no meaning for the market price because these tokens were not originally in circulation, and repurchasing from the market can generate external buying pressure for platform tokens.

However, besides the "external buying pressure," we cannot ignore the "internal selling pressure." Assuming an exchange repurchases and burns 10 million platform tokens from the market, then sells 1,000 platform tokens held by the team back into the market, the circulating token quantity remains unchanged, and there is no deflationary effect. While Binance has given up the "external buying pressure," it has also eliminated the "internal selling pressure." Therefore, in the long run, repurchasing from the market or burning team-held tokens does not make a big difference.

However, since Binance's restructuring in July 2019, BNB has had the worst performance among the three major platform tokens. This shows that Binance's adjustment to token burning still has a certain impact on prices in the short term. In the first quarter of 2020, Binance burned the largest amount of BNB in history, but since the announcement in mid-April, there has been no significant price growth.

However, the significant difference in performance between BNB and other platform tokens is largely due to OKEx and Huobi's aggressive execution of the so-called "absolute deflation" in the first quarter of this year. These two exchanges not only regularly repurchase and burn platform tokens in the market but also announced the direct burning of team-held platform tokens (OKB burn rate as high as 71.93%, HT burn rate at 38.6%). In other words, they maintain the "external buying pressure" while eliminating the "internal selling pressure." Such a large-scale token burning is expected to bring quite favorable short to medium-term price increases for platform tokens.

Linking Platform and Token Values through Burning

As exchanges cannot legitimately provide "stock dividends" to investors, token burning is a crucial value basis for current platform tokens and the most direct way for the exchange's value to be captured by the platform token. Many valuation studies currently rely on this data to evaluate platform tokens, such as the latest research report released by Token Insight.

If an exchange issues platform tokens without a burning mechanism or other pseudo dividend schemes, and lacks attractive utilities (such as participating in IEOs, voting, etc.), relying solely on fee discounts (which are still unattractive to most people), it is challenging to increase user demand. From an investor's perspective, the primary utility of such platform tokens may only be as a tool used by exchanges in the early stages for fundraising and nothing more.