Reflection tokens have been a hot new token mechanic in the crypto space throughout 2021, especially in ‘Meme-Coins’. Projects use reflections in their token mechanics to draw in new investors by promoting the idea of a token ‘dividend’ whilst also simultaneously disincentivizing selling as holders do not want to lose a percentage of their gains when they sell. This token property can be used to create both high demand and low selling pressure, promoting a ‘buy, hold and earn’ culture, pushing price upwards for projects that employ this tactic successfully.
What are Token Reflections?
Reflection tokens have a ‘tax’ on each buy/sell transaction, where a percentage of the trade value is distributed to token holders, the development team and/or deposited back into the tokens liquidity pool. The tax is imposed on the seller of the token, meaning a percentage of their gain is taken when they sell and redistributed to holders. In some projects, this also affects the buyer with a percentage of the purchase funds also being taxed and redistributed. This happens on every single trade for that token, and thus, the token reflections are random in both timing and size. At times when the coin is being traded very frequently, there could be reflections received by holders every second, or if the trade volume decreases substantially, the reflections may be few and far between.
Implications of Token Reflections
Reflection tokens can be great for investors who want to hold their assets and accumulate more tokens, however, there are some implications that come with these projects. Reflection distributions to token holders are not recorded like a regular send/receive on the blockchain, and therefore, the CryptoTaxCalculator platform is unable to pull in the data of your reflections to account for changes in holdings. If you check the wallet address where you hold the reflection token on a blockchain scanner, you will see there are no incoming transactions for the reflections. As reflections occur whenever a trade occurs, and not on a set cycle or timeframe, these distributions cannot be accounted for using a traditional percentage-over-time calculation either.
Some users will not realise they have purchased a token with reflections until they see the transactions displayed on the CryptoTaxCalculator platform. The ‘buy’ or ‘trade’ transaction will bring in an initial amount of tokens and later, when the reflection token is disposed through a ‘sell’ or ‘trade’, the amount will be different. See the scenario below:
Initially, 1 ETH is traded for 2 million Safemoon Tokens (a popular reflection token).
2 months later, the investor decides to sell the full balance of Safemoon tokens in their wallet. The below transaction occurs:
As you can see, the investor has sold 2.5 million Safemoon tokens back to ETH. There is now a negative balance warning showing on the right of this transaction.
Essentially, this negative balance warning is indicating that the investor has sold tokens that the platform did not know where in the wallet. The extra 500,000 tokens accrued from reflections in the wallet over the 2 months, but as discussed above, there are no blockchain records of these tokens being sent to the wallet. This means that platform cannot ‘see’ where they came from.
In order to correct the negative balance warning, you must create manual transactions (using the Manual CSV Import or the ‘+ add transaction’ button) to account for these reflections and show the platform where they came from. By doing this, you are ensuring all of your tax obligations are met.
It is important to note that, for tokens that have ‘negative reflections’ (the balance goes down over time), the opposite will occur. So even after selling the full balance available in the wallet, the platform will still think there is a remaining balance of tokens, as you sold less than you purchased initially.
Some methods of how you may go about recording the reflections so they can be input to the platform are detailed below.
Taxing Token Reflections
Token reflections are currently a grey area in most tax jurisdictions, and it is difficult to determine whether the reflections would be considered income, similar to 'staking rewards' and ‘Interest’ or whether the gains would only be realised in a capital gains event such as a buy or sell. It would be almost impossible to record each individual reflection as they are random and could happen multiple times a second.
To try and account for your reflections, and be ready to fulfil your tax obligations when there is more clarification, you should record reflections by noting the change in tokens held over a consistent timeframe. For example, if you recorded the change in your holdings over 24hrs or another regular timeframe, consistently, this may be beneficial if there is clarification in how these may be handled in the future. It is worth discussing your options with a tax professional so that you choose an option that suits your personal circumstances.