Why Did This Company 'Burn' $2.6M Worth of Ether?

On May 4, the Ethereum Name Service (ENS) went live and began accepting bids on domain names for the ethereum network. These domain names allowed users to replace the typical ethereum wallet or smart contract address (a unique string of 42 numbers and letters) with an easier to remember .eth address, just like you'd register a .com or .org name on the internet with a domain name service.

Over the past six weeks, people have spent millions of dollars registering their ethereum addresses with the ENS. But as the ENS burn wallet reveals, over $2.7 million worth of ether have also been intentionally removed from the ethereum network—or 'burned'—in the process.

This isn't a conspiracy, however. In fact, it's a way of keeping the system honest and impartial.

In order to register an .eth domain on the ethereum network, you need to start an auction through the official ENS application or a third party like My Ether Wallet. Once you've gotten your domain address figured out, you'll use ether to place a bid on that domain name.

The auction will then be listed on the blockchain for 72 hours where anyone else can bid on it. Importantly, the amount that has been bid and the domain name itself are obscured during that 72-hour window to discourage intentional overbidding. After the 72-hours are up, everyone who bid on that domain must reveal the value of their bid within 48 hours or else they will lose the entire value of their bid. The domain goes to the highest bidder, but they only have to pay as much as the second highest bid.

But the ENS auctions come with an interesting twist. If you bid on a domain name and lose, all of your ether will be returned to your wallet minus 0.5 percent of your bid value. This 0.5 percent will be transferred to the ENS burn wallet, which is inaccessible to everyone, including the ENS developers. All the ether sent to this wallet is removed from the ethereum network forever.

So far, fees from ENS auctions have resulted in the destruction of 7, 730 ether. At the time of writing, this amounts to about $2.7 million USD.

This bidding style is known as a Vickery auction, which was designed so that bidders would bid truthfully. Basically, it prevents bidders from jacking up the price since they don't know how others are bidding on the item up for auction. This means they must bid based on the value that they actually attribute to item.

Although $2.7 million burned seems like an incredible waste, it's a necessary part of what makes the Vickery system work. For starters, the 0.5 percent bid fee deters people from bidding on every single domain name that goes up for auction in the hopes of selling them later at a higher price. According to Nick Johnson, a software engineer at the Ethereum Foundation, it also helps prevent extortion.

As Johnson explained to me over email, since bids on domain names are sealed, no one can know for sure which domain names a person bet on. If there is a valuable domain name up for auction and no fees on bidding, a ne'er-do-well could place a series of increasingly high bids on the auctions that they think are related to that domain name. Once the auction is up, that person would wait for the original bidder on that domain name to reveal their bid. After the initial bid is revealed, the ne'er-do-well could contact that bidder and threaten to reveal their own bid—valued just slightly less than the original bid—unless the original bidder pays them a fee.

"Since the winner pays the amount of the second highest bid, this would increase their costs a lot, without costing [the extortionist] anything," Johnson said. "If bids are lost if they're not revealed, this extortion attack becomes impossible."

But many wonder if that fee couldn't be put to better use than total destruction—such as donating it to the non-profit Ethereum Foundation, for instance. According to Johnson, however, burning the ether helps keep the system honest.

"We decided to burn fees because it's the least contentious option," he told me. "It's the only one guaranteed not to create conflicts of interest or perverse incentives."

Moreover, burning the ether isn't really destroying it. Rather, it's a method of distributing the value of the burned ether to everyone with a stake in the ethereum network.

"By removing the ether permanently, the value of still available Ether becomes higher," Johnson said. "Imagine you deleted half of everyone's funds: the remaining funds would double in value, preserving the overall value in the system."