Burn Baby Burn, Fiscal Inferno! How Burn Mechanics in the Money Supply Kill Inflation Forever

Burn Baby Burn, Fiscal Inferno! How Burn Mechanics in the Money Supply Kill Inflation Forever
Photo by Tengyart / Unsplash

“It was a pleasure to burn”, starts Fahrenheit 451. The dystopia sci-fi’s flame wielder was burning books, but it’s a sentiment that many crypto users would echo. ‘Burning’ crypto means to destroy it, irrecoverably and forever, and reduce the maximum supply of any given token.

Holders of any digital asset enjoy watching a portion of the supply burn because it means the crypto they have is more valuable as it is more scarce. In less purely self-interested terms, deflationary assets make good economic sense for all holders of a token. It’s also desirable for a money-supply to be deflationary because - well - it stops inflation. Crypto’s proto-goal.

Bitcoin’s model isn’t quite deflationary. By making changes to the Bitcoin Core to more closely resemble that of spiritual successor BitGessell, Bitcoin can take this final step to accelerate value to all holders.

The Effects of Burning

By increasing its value through scarcity, it also increases desire for the token, thereby increasing both its fungibility and use cases. Crucially, it makes for deflationary pressure on the currency, so that its value increases over time, and the use of it combats inflation in the general economy. This is a core goal of the crypto community: to combat inflation as a result of quantitative easing or other policies that increase the overall money supply and devalue the savers in the economy.

Burning in most modern proof of stake cryptocurrencies is very common. Solana, to take just one example, burns a portion of the transaction fees. Much of the total supply is still locked up as staking rewards for early investors, the emittance of which causes downward price-pressure as they sell the asset. The counterbalance of the fees being burnt decreases this pressure, and the eventual full distribution of the coin ultimately results in the asset becoming deflationary over time.

Deflation, Disflation and Bitcoin

Deflation, although an intuitively scary term as it implies price decline and lack of growth, really means just a reduction of the money supply over time; something that need not be correlated with a lack of productivity or economic growth.

Bitcoin has a total max supply of 21,000,000 coins It is ‘deflationary’ in the sense that, unlike fiat or any other coin with no max supply and constant creation, once that supply is reached but the human population who wants it increases inline with population growth, then the value of the coin will go up. Although current models indicate population growth will flatline by 2100, meaning this factor will be limited in its effect going forward.

If there is no max supply, there is a constant threat of inflation of a currency devaluing savings. This idea of terminal supply being “deflationary” is heavily contested, though, particularly in Bitcoin’s case. Bitcoin more properly could be called ‘disflationary’.

Disflationary currencies are good at combating inflation as the money supply doesn’t increase, and with the long tail of Bitcoin’s halving and block mining rewards decreasing, the amount of Bitcoin available is decreasing every passing year. Yet it’s not quite full-fat deflation, built into the code, like most modern protocols are. Improving the Bitcoin Core codebase to include a burning of bitcoin through transactions would be a significant evolution to the world’s digital gold, and would lead to a significant upswing in its value as it competes with newer protocols with inbuilt deflationary economics.

Successful Implementation of Burns by Ethereum and BNB

Ethereum, which has no max supply, sought to combat the issue of its unlimited supply with the EIP 1559 change to codebase. The change meant transaction fees which previously went to Ethereum miners on the creation of a new block were burned instead. This change was implemented on August 5th, and so far near $3.5 billion of Ether has been burned.

Since the implementation, ETH’s price has nearly doubled, as although ETH’s supply is infinite, the burning contributes to reducing the money supply and increases the scarcity and value of the coin, with no effect on its utility. This is because the burn mechanics do not affect users, they only affect miners (who are already being rewarded) and the coin supply. BNB has followed suit. The investing community behind a coin only benefits, and deflationary economics is the goal.

How Bitcoin Can Adopt True Deflation

A similar BIP aimed at echoing Ethereum’s implementation of burn mechanics would be excellent to further propel BTC. A sensible implementation of burn mechanics that does not immediately affect the current progression of the Bitcoin economy (which, by any measure, is doing very well already) but would over time transition Bitcoin from a disflationary to a deflationary model over the next 20 years.

By that time, Bitcoin will likely be the world’s most valuable asset. By introducing burning, and thus implementing a deflationary model over time, it would continue to increase price upside for holders and Bitcoin’s place as a store of value. There would also be an indirect contribution to its value by its general use as  a currency.

Introducing a Burn Mechanic to the Bitcoin Core

The proposal to introduce burn mechanics has been created at https://github.com/bitcoin/bips/pull/1237 with the description at https://github.com/wu-emma/bips/blob/draft/bip-burn/bip-burn.mediawiki

By dynamically burning a portion of the transaction fees in line with current mining difficulty, Bitcoin’s role as digital gold could be improved upon. Unlike gold, deflationary effects would continue over time, it would be easy to transact as a global currency, and the minting mechanics of digging for new currency could be made more efficient and related to be rewarded through mining new blocks rather than also collecting transaction fees (and thus preventing stultifying debates about block size).

The burn rate’s dynamic altering could also act as a way to regulate excessive environmental impact caused by mining, a key criticism of Bitcoin’s primacy in the crypto space. All the while, the value of every Bitcoin would go up.

Such an implementation of transaction fee burning would only affect miners. However, as mining technology improves, there will be increasing redundancy in the difficulty of bitcoin and its ability to be effective as a tool of deflation. Future generations of miners will likely be exponentially more technologically advanced, and have larger operations in place.

By carefully introducing burn mechanics that don’t take significant effect until more halving take place, the miners that secure the network would not be adversely affected (as the current block subsidy is far higher than the transaction fee), and be ultimately rewarded by the increase in asset price and their ability to mint coins in the future of increasing value.

BitGesell Can Make These Changes

BitGesell, a spiritual successor to bitcoin, (and whose name is derived from the aforementioned Silvio Gesell) already has this model built-in to its protocol. It’s easy to imagine that this dynamic burning could also be implemented into the Bitcoin Core.

As the ratio between block subsidy to fee is so low, it won’t have a significant effect on scarcity in the medium term but, in the long term, when Bitcoin has established itself as the world’s global value reserve, it would function as a way to continue that upward trend into the infinite future, increase desire to spend and loan it, and dynamically regulate the mining of future coins so that a constant deflationary effect in the money supply is achieved.

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