Blockchain technology is an invention that is highly innovative. However, for this innovative technology to function, it needs an efficient and secure consensus algorithm. The function of such an algorithm is to ensure the validity of the technology and safeguard it from external manipulations.
The most commonly used algorithms in cryptocurrency are proof of work (POW) and proof of stake (POS). There are quite a lot of other alternative methods that only a few people know about. One of such methods of consensus is Proof Of Burn (POB) which is otherwise known as coin burn. In this method, an individual is required to burn a mined currency such as bitcoin in exchange for tokens of an alternative currency.
Here’s a detailed explanation of everything that a beginner need to know about coin burn.
What is coin burn?
Coin burn, otherwise known as proof of burn is a method of distributed consensus. It is a readily alternative for proof of work and proof of stake.
The whole idea of this is that an individual should provide proofs to show that they burned some coins, by sending them to a verifiable address that is not spendable. This could seem expensive from their individual point of view, but it does not consume resources other than the burned underlying asset.
How coin burn works?
Coin burn, otherwise known as proof of burn works in a simple and easily understandable manner. Coin miners send coins to a nonspendable address aka an eater address, effectively "burning" them. Coins cannot be accessed or spent again once they have been burned. Burned coins are recorded on the blockchain, and because of this, there is enough evidence that the coins cannot be utilized again.
The idea behind this whole concept is that coin burn signifies a user's willingness to make losses in the short term while he is expecting more investments in the future.
Users are rewarded over a long time through a mechanism that is put in place for proof of burn. The more coins that a user burns, the bigger the chance that he will have to mine the next block.
Coin burn (proof of burn) can be implemented in different unique ways; For example, the coin burned may be that of the user's native currency or that of an alternative currency. Your stake takes a downward dive over time when you burn coins. The urge to maintain a good odd of being selected for mining the next block is enough motivation to make you burn more coins over time.
Eater address
In proof of burn algorithms, eater address is a tool used to store coins that have been burned. Eater addresses are actually valid addresses for trading bitcoin. These addresses are generated randomly and not from specific private keys. Eater addresses are not suspendable basically because they cannot be backward calculated.
Proof of burn as a transition tool between cryptocurrencies
As a method for distributed consensus, proof of coin is an alternative to proof of stake and proof of work. Its other use is bootstrapping one online currency off to another.
The idea behind all these is that miners/participants should show proof that coins were really burned. As previously discussed, this can look expensive from an individual perspective, just like proof of work and proof of stake, but in the real sense, it consumes no resources other than the underlying asset that is burnt. It is right to say that the ultimate source of scarcity remains the fuel that is mined from proof of work.
In some other scenarios, you will get a special right to mine blocks in the proportion of the coins that you have burnt. You can think of this as virtual mining set-up.
The above scenario is typical in XCP(counterparty). XCP was originally not mined nor sold in an ICO. Its existence was birthed by using the proof of burn method.
Advantages of coin burn
It is quite a valid argument that a proof of burn protocol encourages a long-term involvement in a project because prices will gain a greater level of stability since there is a greater percentage of investors willing to invest in the long term.
Proof of burn encourages the fair distribution of cryptocurrency in a decentralized manner. This is contrasting to the proof of works methodology that is used in the likes of bitcoin, where we have seen the centralization of mining.
Proof of burn is an excellent way of seeding new currencies.
Coin Burn ensures fair play if the tokens or coins initially allocated for an ICO is not completely sold. By sending those coin to an unspendable public address, it makes sure that the company does not just have an unfair amount of surplus token which they can sell at an appreciated price when the coins hit the exchange. Basically free money for them.
Disadvantages of coin burn
One of the most valid criticisms of proof of burn is that it involves wasting of resources just like proof of work albeit indirectly.
Another major criticism of proof of work is that it allows mining power to go more to those who are willing to burn more money. This is a case similar to what is obtainable in proof of stake where it has been argued that the rich get even richer.
In proof of burn, there is no substantial guarantee that a user will recover the complete value of burned coins. This makes proof of burn quite a risk.