Arguably the most dynamic segment within the crypto ecosystem, decentralized finance (DeFi) projects have been revolutionizing how cryptocurrency inve
Arguably the most dynamic segment within the crypto ecosystem, decentralized finance (DeFi) projects have been revolutionizing how cryptocurrency investors can employ their tokens to access capital and even earn additional income on their crypto holdings. However, using DeFi products such as yield farming, liquidity mining and staking pools can often be a cumbersome experience for most crypto investors.
To solve this problem, a new class of crypto tokens was introduced in 2021 that integrated self-generating passive income mechanisms to reward investors with supplementary crypto tokens. Known as reflection or reward tokens, these digital assets are increasingly gaining traction among crypto investors who are looking to harness the long-term potential of holding on to their cryptocurrency portfolio.
Understanding reflection tokens
Apart from the long-term price appreciation potential of cryptocurrencies, crypto investors are often found wanting an option to earn additional income from their tokens during the holding period. Considering that cryptocurrency markets can witness volatile price actions, short-term trading where traders try to record gains by selling high and buying low can be an extremely risky proposition.
Similarly, DeFi products that require investors to deposit their crypto holdings in lieu of daily, weekly or monthly returns are a plausible option but are fraught with concerns, such as suffering from impermanent loss, rebalancing losses and even smart contract hacks that allow scammers to steal investor funds.
In stark contrast, crypto reflection tokens or reward tokens encourage investors to hold on to their tokens, thereby promoting market stability while still offering investors the chance to earn incremental income on all transactions being made on the protocol.
They utilize a built-in fixed reward mechanism that allocates a percentage of gas or transaction fees to be redistributed among tokenholders. This allows reflection tokenholders to earn additional crypto tokens in proportion to the number of tokens they own as compared to the total token supply. Some reflection tokens also apportion a part of the proceeds toward one or many liquidity pools, which are further used by decentralized exchanges (DEXs) to provide ample token liquidity.
The reward mechanism is driven by smart contracts that automatically tax every transaction and subsequently transfer the equivalent tokens as per set rules. The smart contract may be programmed to update the value of the reflection token on a regular basis, or it may be triggered by specific events or conditions.
For example, the smart contract could be programmed to distribute a fixed percentage of the value of the underlying asset to holders on a daily or weekly basis. Alternatively, it could be triggered by certain conditions, such as the price of the underlying asset reaching a certain threshold or the completion of a specific task.
The smart contract is responsible for enforcing the terms of the agreement between the reflection token holders and the issuer of the token. It executes the terms of the agreement automatically without the need for intermediaries or manual intervention. This can help to ensure that the terms of the agreement are carried out transparently and fairly.
However, smart contracts are only as reliable as the code that powers them, making it important that the code is tested and vetted before being deployed to power the reflection tokens’ reward mechanism.
Benefits of reflection tokens
By virtue of their smart contract-backed tokenomics, reflection or reward tokens not only create value for all tokenholders but also serve to stabilize the token’s market value by encouraging investors to hold for the long term. As long as the underlying project remains successful and token transaction volumes keep increasing, investors can earn passive income with reflection tokens without any additional hassles.
Unlike staking or yield farming, in which rewards are dispensed as per an extended schedule, reflection tokens provide real-time returns to all tokenholders in the form of additional tokens. These rewards can be exchanged for other cryptocurrencies or even fiat currencies through DEXs, such as PancakeSwap, Uniswap and dYdX, among many others.
Related: What is dYdX? A beginner’s guide to trading on a decentralized exchange
Drawbacks of reflection tokens
Despite the apparent advantages of reflection tokens, there are a few aspects that investors ought to keep in mind before investing in them. Firstly, the transaction fee or tax applicable on these reward tokens can be as high as 10% and is to be borne on both purchases and sales. This necessitates that tokenholders remain invested for a longer period of time in order to recoup the transaction tax outgo, through token rewards and/or the overall price appreciation.
Additionally, the redistributed token amount depends on the overall transaction volumes of the native token, which could…
cointelegraph.com