The crypto market has experienced massive growth in the past year, partly due to the rise of DeFi innovations enabling investors to earn an income on their crypto holdings.
Innovations such as staking, yield farming, and liquidity mining have attracted billions to the decentralised finance market. Another lesser-known innovation that stems from the growth in DeFi is reflection tokens.
Continue reading to learn exactly what are reflection tokens and how they work.
Reflection tokens are cryptocurrencies that reward holders by employing a mechanism in which transactions are taxed and a percentage of the tax charged is redistributed to holders of the token.
One of the reasons behind the tokenomics of reflection tokens is to prevent large price drops new cryptocurrencies often face from whales during their price discovery phase.
Also, since holders are rewarded with new tokens, the mechanism incentivises investors to hold onto their tokens long-term. Because of this, reflection mechanisms are seen as an effective way of keeping investors loyal to a project.
While DeFi tokens typically allow investors to earn an investment income through staking, liquidity mining and yield farming, reflection tokens are gradually becoming another way to earn yield on crypto assets.
Tip: Whale is a cryptocurrency term that refers to individuals or entities that hold a large amount of a specific coin. Whales hold enough of the crypto coin that they have the potential to manipulate the valuation of the cryptocurrency.
With reflection tokens, every transaction in the network is taxed. Most protocols tax 10% of every transaction, which is usually distributed among all holders, a liquidity pool, and sometimes a coin burn wallet.
With this mechanism in place, investors can gain more tokens by “HODLing” the token, while also benefiting from a potential price appreciation that may occur through coin burns.
The reflection mechanism is decentralised and trustless as it's managed by a smart contract that automatically distributes tokens across the wallets of all holders, a liquidity pool, and a burn wallet. All that holders have to do is to ensure they manage their wallets carefully.
The whole process is transparent as every wallet that receives a part of the fee can be publicly audited on the blockchain.
Below are some of the popular crypto projects using reflection tokens:
Safemoon is one of the earliest cryptocurrencies to implement a reflection mechanism. The project, which was launched in the first quarter of 2021, has garnered over 2.5 million holders with over 585 trillion coins in circulation and a market cap upside of $2 billion.
Safemoon's reflection mechanism is aimed at reducing volatility by encouraging investors to hold onto their tokens. The mechanism uses a smart contract that charges a 10% fee for every transaction. Half of the fee is split among holders, according to their token balance, while the other half goes to Safemoon's liquidity pool to ensure there's liquidity for buyers and sellers. Review the SafeMoon tokenomics to understand how the key mechanics work.
TIKI is a next-generation reflective token on the Binance Smart Chain. The project enables investors to earn BNB just by holding tokens in their wallets. Its reflection mechanism charges a 15% fee for every buy/sell. 10% of the fee is converted to BNB and automatically redistributed back to holders with a minimum balance of 10,000 TIKI, while the remaining 5% goes to the liquidity pool on Pancakeswap to maintain a price floor.
To reduce price swings and break the control of whales, TIKI restricts sales to less than 0.1% of the total supply as any transaction above the limit is denied. On top of that, an additional 3% is charged on sell orders. According to Tiki Token's website, holders can also stake their tokens via BankerDoge while earning more rewards in TIKI and BNB.
RFI is a reflective token on the Ethereum network that enables token holders to earn passive income. The project applies a 1% fee for every transaction that's automatically split and distributed among holders. In RFI, 100% of the fees generated goes directly to holders. The percentage each holder receives is proportional to the amount of RFI tokens they hold.
In addition, RFI holders can also use their tokens for yield farming or staking as the RFI smart contract can determine the rewards earned by each holder even when the funds are pooled together.
Other reflection tokens include HODL 2.0 and GhostFace.
Recommended reading: What are liquidity pools and how do they work?
While reflection tokens look promising because of their interesting crypto income earning mechanisms, they also have downsides. Let’s dive into the benefits and drawbacks on these innovative new tokens.
While the tokenomics of several cryptocurrencies - reflection tokens included - are deflationary, another class of cryptocurrencies known as hyper-deflationary tokens goes even further.
By using a smart contract that burns a certain percentage of every transaction, hyper-deflationary tokens ensure that their circulating supply is constantly reducing. Another method employed in these tokens is to conduct regular buybacks to reduce supply.
In hyper-deflationary tokens, the fees charged are usually sent to a burn wallet, meaning the tokens are wiped out of existence. Holders do not receive transaction fees as a reward. Rather, they gain from the price increase caused by the burn.
Some crypto projects combine both mechanisms to build potentially attractive tokenomics models for token holders.
While there’s no direct answer to this question, the rule of thumb before trading any tokens is to do your own due diligence by conducting thorough research about the project.
Reflection tokens provide a new way of earning passive income that is yet to stand the test of time. Most of the cryptocurrencies using reflection mechanisms are new, considering they haven't been around for more than a year.
Your decision to trade reflection tokens should be based on your risk tolerance level - are you ready to take on the risk of investing in a fairly new promising model or do you prefer to observe the long-term effect on the market before investing any money?
Whatever decision you take, always remember that every crypto investment has its own fair share of risks.
We hope that this guide will help you on your journey to buying, holding, and trading crypto. You can start trading cryptocurrency CFDs with Axi today.
The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.
Ethereum is the second largest cryptocurrency in the world and for good reason, with it's smart contracts functionality and booming NFT and metaverse marketplace.