Following 2017’s proliferation of token sales and, with it, the deluge of new economic models for crypto assets and accompanying valuation frameworks, one mechanism seems to have stuck – token burns. Token burning is the process by which a given amount of a crypto asset is permanently removed from the circulating supply in order to decrease the overall supply of that particular crypto asset. This process is often marketed as equivalent to fee- or profit sharing, dividend distributions, or stock repurchasing; however, this research note will argue that token burns have distinct differences which impact the extent to which they can be considered a value proposition for a given crypto asset. We focus on examples of token burning where the most data is available – Binance Coin (BNB), Bibox Token (BIX), KuCoin (KCS) and Maker (MKR). Throughout this research note, we focus on the US dollar value of the token burn on the day at which the burn occurred to account for price fluctuations of the underlying crypto asset.
Exchange Tokens – BNB, BIX, & KCS
The exchange tokens – BNB, BIX, and KCS – offer the best data sample to compare token burns between crypto assets. All three assets use token burns as a means of ostensibly transferring value from the exchange to the token holders – we will go into the specifics later in this section. Below, we plot the burn amounts of the tokens over time and indicate their US dollar value:
The burn mechanism generally acts as the primary value accrual method for the crypto assets; as such, we introduce the Price to Burn ratio as a metric to compare the value the market attaches to the mechanism on a per unit basis. The Price to Burn ratio is calculated as the crypto asset’s market capitalization divided by the cumulative number of tokens burned. Below, we plot the ratio from the start of 2019.
The ratio demonstrates the premium that investors are paying for the number of tokens burned; for example, the fact that BIX’s ratio is more than half of BNB’s is an indicator that – solely based off the crypto assets’ burn function – the latter is overvalued to the former. It should be noted however that such an analysis ignores the many other value propositions a given crypto asset could have or even the differences in their implementation of the burn mechanism.
The table below outlines the features of each crypto asset’s burn mechanism:
Maker – MKR
Maker (MKR) is another good example of a crypto asset with a burn mechanism. In this system, those who create loans using the Maker credit facility must pay a fee (the “stability fee”) which is then used to buy MKR and burned[i]. The chart below plots the total amount of MKR burned over time since the launch of the credit facility in December 2017. Note that these figures do not include liquidation penalties which are currently used to burn Pooled ETH (PETH) and not MKR.
Moreover, we plot the Price to Burn ratio for Maker.
One thing that should be noted is the large premium (as measured through the Price to Burn Ratio) the market seems to be valuing Maker at compared to the exchange tokens. For example, Maker’s ratio has generally hovered between 600 and 1200 compared to 10 and 90 for the exchange tokens. The key reason for this is due to Maker’s price being less a function of its current accrued stability fee but, rather, future expectations of accrued stability fees. While in an exchange token like BNB’s case, its mechanism means that (1) large amounts of tokens are currently being burned and their ostensible effect has already been priced in, and (2) the upper bound of the total amount of crypto assets available to be burned may place an upper bound on the Price to Burn Ratio.
Token Burns and Valuation
Those within the industry have often compared token burns to stock repurchases but we believe such a comparison is weak. The limits of this comparison have been picked up on by those within the industry such as Spencer Bogart of Blockchain Capital:
A separate concern is around the token model for MKR. There’s been an over-reliance on the notion that Burns = Buybacks = Dividends. This is borrowed from the equity world where buybacks *are* ~= dividends.
— Spencer Bogart (@CremeDeLaCrypto) March 6, 2019
The value of a stock repurchase is its ability to increase the cash each unit of stock is entitled to which, under a discounted cash flow valuation method, will increase the value of said stock, other things being equal. This logic does not hold for token burns as, even though the token burn does, in fact, reduce the crypto asset’s circulating supply, these tokens offer no claim on another cash flow upon which to predicate a discounted cash flow valuation.
This fact, however, does not mean that token burns cannot be seen as value accrual mechanisms. In cases where the token burn relies on an auction process wherein units of the crypto asset are bought from the open market and then burned, it is possible to theorize upon reasons why such a mechanism should impact the valuation of the crypto asset. Such a theory though would rely on a constant and automated process for the purchasing and burning of the crypto asset from the open market. We can theorize that in such circumstances an arbitrage pricing argument would suffice to explain why a crypto asset could be valued at a given price assuming the existence of the aforementioned constant and automated buyback and burn mechanism. In the case of the exchange tokens, it is likely that their burn mechanism does not rely on open market buybacks but rather the burn of the crypto asset’s supply already held by the exchange. It is unclear in such a case why this mechanism should necessarily lead to the accrual of value to the given crypto asset.
This research note has explicated the concept of token burns and demonstrated several crypto assets which have implemented the mechanism – BNB, KCS, BIX, and Maker. We demonstrate how the exact implementation of the mechanism affects its impact on value accrual. Notably, we argue how it is fallacious to consider token burns analogous to stock repurchases due to the lack of intrinsic cash flow in the former’s case. Instead, a promising valuation methodology for buy back and burn crypto assets could be formulated on the back of an arbitrage pricing argument – however, it relies on a mechanism wherein units of the crypto asset are automatically bought from the open market and then burned.
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[i] Technically, the Maker used to pay the stability fee has not in fact been burned, but instead deposited at the following address where the only action that can be performed on its account balance is the burn function.