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What are reflection tokens and how do they work?

Yield farming, liquidity mining, and staking have become common practices in the crypto market due to the remarkable growth the DeFi ecosystem has witnessed in recent years. These features enable users to earn interest on their crypto holdings by locking them as deposits for specific periods.

The concepts sound appealing but there's one big risk: the potential decline in the valuation of the locked assets. In other words, users will see losses in U.S. dollar terms if the asset's value drops during the lock-in period.

These shortcomings have raised "reflection tokens" as a viable alternative. In theory, reflection tokenomics remove the necessity of locking tokens while still offering staking-like benefits.

What are reflection tokens?

The projects backing the reflection tokens charge a penalty tax (calculated in percentages) on each transaction. In turn, they give out the fee to all token holders depending on the percentage of assets they hold.

As a result, reflection tokens' holders do not need to lock their assets for a certain period to earn rewards. They earn their income almost instantly in most cases when a transaction is made, with the functions governed by a smart contract.

Reflection tokens' illustration

In addition, users can deposit their reflection tokens in third-party lending and yield farming contracts to earn additional yields. But while the combination of incentives for holding and staking theoretically reduces sell-side pressure, this has not been the case with most reflection assets.

Popular reflection tokens

Some of the most popular reflection tokens include: SafeMoon (SAFEMOON), BabyFloki (BABYFLOKI), FlyPaper (STICKY), MinersDefi (MINERS), and EverGrow Coin (EGC).

For instance, EverGrow Coin (EGC) 's price dropped nearly 98% after peaking at $0.0000039298 in November 2021. This project takes 2% of its network fee and distributes them in the form of Binance USD (BUSD) tokens across the EGC holders.

EGC/USD weekly price chart. Source: TradingView

The EGC weekly chart above shows its bearish price trend accompanying very low trading volumes, suggesting that the buying and selling on its network died down after the early hype. Less volume means lower rewards for EGC holders, which may have prompted them to sell their assets.

Risks associated with reflection tokens

Reflection tokens give holders the benefit of growing their passive incomes with immediate reward distributions. Nonetheless, they carry specific risks that could impact investors' profitability. Let's have a look:

Transaction tax

Projects asses transaction tax when users buy and sell reflection tokens. In other words, first-time buyers typically pay a transaction fee which they can recoup only if the project gains adoption. As a result, it could take months for investors to see profits.

Related: Top-five most Googled cryptocurrencies worldwide in 2022

Scams

Scammer can misuse the growing reflection token trend just as any other digital tokens. They could dupe investors into paying initial transaction taxes, only to abandon the project midway and abscond with all the invested funds.

Uneven returns

Reflection tokens do not guarantee consistent returns given the yields depend on the asset's day-to-day volume. There's a possibility that a token may generate zero yields in the event of no activity on its network.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.

Original Article

About Jude Savage

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