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Buyback & Burn

Systematically repurchases tokens from the market using protocol revenue and permanently removes them from circulation through burning, creating revenue-linked buy pressure and reducing total supply over time.

Buyback & Burn uses protocol revenue to systematically purchase tokens from the open market. Once purchased, these tokens are permanently removed from circulation by being sent to an irretrievable address, making them unusable. The mechanism functions as a perpetual, autonomous buyer that never resells acquired tokens, creating constant buy pressure while simultaneously reducing the total token supply over time. Assuming a token’s market capitalization remains the same, the reduction in token supply should theoretically cause a proportionate increase in token price, thus enabling token holders to capture value in the form of unit price appreciation.

The mechanism is inspired by stock buybacks in traditional finance. Unlike corporate stock buybacks which can be reversed through new issuance, blockchain token burns are permanent and irreversible. MakerDAO pioneered this mechanism onchain, by requiring the stability fees from DAI loans to be paid by burning the equivalent in MKR tokens. Maker later transitioned this to a continuous auction system which separates the payment of stability fees from the buyback and burn operation. The success of this model led to widespread adoption across DeFi protocols as a way to align protocol revenue with token value appreciation.

Advantages

  • Value Alignment: Directly ties token value to the revenue or profits generated by the platform, ensuring that token holders benefit as the ecosystem succeeds.
  • Price Stability: Regular buybacks provide a price floor or cushioning effect during market downturns, potentially reducing price volatility.

Limitations & Risks

  • Missed Capitalization Opportunities: Burning tokens eliminates the potential to reuse them for productive purposes, such as incentivizing contributors, raising funds, or supporting ecosystem expansion, which are key to sustainable growth.
  • Market Distortion: The constant buying pressure may create artificial price floors that don't reflect true market conditions.
  • Short-termism: The focus on scarcity and price increases can misdirect efforts from long-term network development to short-term price manipulation, risking the project’s sustainability.

Design Considerations

  • Revenue Source: Define whether buybacks are funded by transaction fees, lending fees, protocol earnings, or other revenue streams.
  • Buyback: Optimize buyback timing to avoid front-running or manipulation. Possible approaches include randomized buybacks, where purchases occur at unpredictable intervals to prevent price distortion, or algorithmic buybacks, where buy orders are triggered based on predefined metrics like token price volatility or liquidity conditions.
  • Burn: Determine the proportion of tokens that should be permanently removed versus repurposed. Alternatives include partial burns, where some tokens are reallocated for staking rewards, governance incentives, or ecosystem growth, and auto-compounding models, where a portion of buyback funds is reinvested into yield-generating activities before burning.

Resources

  • Buyback and Burn Mechanisms: Price Manipulation or Value Signalling? (Darcy W E Allen, Chris Berg & Sinclair Davidson)

  • An Economic Analysis of EIP-1559 (Tim Roughgarden)

Examples

MKR Token

Used a two-phase buyback and burn mechanism for its governance token MKR. Initially, the protocol required DAI borrowers to pay stability fees by directly burning MKR tokens. In 2020, this was enhanced to a surplus auction system where excess DAI from stability fees is first auctioned for MKR tokens through the protocol's Flap Auctions, after which the acquired MKR is burned. This separation of fee collection from token burning allowed for more efficient price discovery and reduced friction for users who no longer need to acquire MKR to pay fees. In 2023, Maker transitioned away from buyback & burn entirely, opting instead for a buyback & make model that accumulates protocol-owned liquidity.

Ethereum EIP-1559

Adopted and activated on August 5, 2021, as part of Ethereum’s London Hard Fork. It incorporates a burn mechanism where a portion of transaction fees (the base fee) is permanently removed from circulation, creating a deflationary effect similar to traditional buyback and burn models. Unlike buybacks that rely on treasury income to repurchase tokens and signal confidence, EIP-1559’s burn is intrinsic to the protocol and tied directly to network usage, not treasury management.

BNB Token

Operates one of the most comprehensive token burn programs, utilizing multiple mechanisms. The Auto-Burn System, introduced in December 2021, replaced the original quarterly burns by automatically calculating burn amounts on-chain based on BNB price and block generation, with a target to burn 100 million BNB (half of the total supply). The Real-Time Burn (BEP-95), implemented in November 2021, continuously burns a portion of gas fees from each block and will persist even after the 100 million BNB target is reached. Additionally, the Pioneer Burn Program removes extra BNB equivalent to provably lost user funds, with these amounts counted toward the quarterly burn total.