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 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 removes the necessity of locking tokens while 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 issue fees to all tokenholders depending on the percentage of assets they hold.

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

Reflection tokens illustration

Additionally, users can deposit their reflection tokens in third-party lending and yield farming contracts to earn more yields. But while the combination of incentives for holding and staking theoretically reduces sell-side pressure, this has yet to be the case with most reflection assets.

Popular reflection tokens

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

For instance, EverGrow Coin’s price dropped nearly 98% after peaking at $0.0000039298 in November 2021. This project takes 2% of its network fees and distributes them in Binance USD (BUSD) tokens to 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 benefit holders by growing their passive incomes with immediate reward distributions. Nonetheless, they carry specific risks that could impact investors’ profitability.

Transaction taxes

First-time buyers typically pay a transaction tax or fee, which they can recoup if the project gains adoption. However, it could take months for investors to see profits.

Related: Top-five most Googled cryptocurrencies worldwide in 2022

Scams

Scammers can misuse the growing reflection token trend like any other digital token. They can dupe investors into paying initial transaction taxes, only to abandon the project midway and abscond with the invested funds.

Uneven returns

Reflection tokens do not guarantee consistent returns, given that the yields depend on the asset’s daily volume. 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.