Examining the Purpose of Burning Mechanisms in Cryptonetworks

  • Commentary
  • September 27, 2020

In a recent article, Joel Monegro, a Partner at the cryptoasset-focused venture capital firm Placeholder, provided criticism of buyback-and-burn models, offering an alternative method, termed buyback-and-make, as a supposed improvement. Smith+Crown recently suggested practical improvements to how buybacks could be conducted and Monegro’s thought-piece challenged our thinking about the purpose of burning bought-back tokens in the first place.

A key premise in Monegro’s argument is that burning of non-currency tokens (i.e. cash flow generating and governance tokens) is a misguided effort. Pointing to traditional equity markets, the author highlights how, when repurchasing stock, companies do not destroy the equity but rather lock it up in their treasury, removing it from the asset’s free float count. This highlights how lockups generally achieve the same ends that destruction would. In the case of cryptonetworks, Monegro suggests that bought-back tokens would be better handled by protocols and to the benefit of all interested stakeholders, were they to be used in a more constructive manner, such as providing liquidity.

While Monegro offered an alternative model, which we encourage readers to read, without any practical case studies, we deferred on endorsing or critiquing his particular solution and instead considered the purpose of burning mechanisms more generally. While burning can play an important role in some protocols, including but not limited to alternative forms of consensus, identity systems, creation of new assets, and notarization, we agree that their application to buyback programs is misplaced. Indeed, the same result, namely proving that tokens have been removed from liquid supply, can likely be achieved through other methods, such as timelock contracts, albeit these are not completely foolproof. The use of timelocking or similar mechanisms offers protocols greater flexibility by creating the possibility of a future spendable treasury should it be needed, while also placing cryptographic assurances on the illiquidity of the tokens for a period of time, thus achieving the same value-accrual benefit of burning.

In our view, proposals such as Monegro’s accompanies other more sophisticated recent thinking within the industry related to cryptoeconomics and how tokens can accrue value while also benefiting a protocol’s growth and its associated stakeholders. These analytical efforts represent a significant maturation of the space generally and token design especially compared to previous cycles, most notably the 2017 ICO period.