What Are Leveraged Tokens?

Leveraged tokens are ERC20 tokens that have leveraged exposure to crypto.  It is very similar to the leveraged ETF in traditional financial market. What the difference is that there will no margin requirement in trading leveraged tokens. Users just need to buy/sell like spot trading to realize certain times of leverage. There are two concept involved: net value and underlying position. The demand & supply relation in secondary market determines the price, while, theoretically, the price is pegged to the net value. 

For example, take ETHBULL, a 3x long ETH token.  For every 1% ETH goes up in a day, ETHBULL goes up 3%; for every 1% ETH goes down, ETHBULL goes down 3%.

Note: Leveraged tokens are spot trading pairs, so thoretically, there is no liquidation risks. However, under extreme conditions there’s possibility that the price will approach 0. Users need to learn the product carefully before investing. The product may bring great loss in a day. Please be cautious of the risks. 

How Do Leveraged Tokens Work?

Each leveraged token gets its price action by trading perpetual futures. 

Why Use Leveraged Tokens?

There are three reasons to use leveraged tokens.

Managing Risk

Leveraged tokens will automatically reinvest profits into the underlying asset; so if your leveraged token position makes money, the tokens will automatically put on 3x leveraged positions with that.

Conversely, leveraged tokens will automatically reduce risk if they lose money.  If you put on a 3x long ETH position and over the course of a month ETH falls 33%, your position will be liquidated and you will have nothing left.  But if you instead buy ETHBULL, the leveraged token will automatically sell off some of its ETH as markets go down–likely avoiding liquidation so that it still has assets left even after a 33% down move.

Managing Margin 

You can buy leveraged tokens just like normal ERC20 tokens on a spot market.  No need to manage collateral, margin, liquidation prices, or anything like that; you just spend $10,000 on ETHBULL and have a 3x leveraged long coin.

ERC20 Tokens

Leveraged tokens are ERC20 tokens.  That means that–unlike margin positions–you can withdraw them from your account!  You go to your wallet and send leveraged tokens to any ETH wallet.  This means you can custody your own leveraged tokens; it also means you can send them to other platforms that list the leveraged tokens.

How Do You Buy/Sell Leveraged Tokens?

Spot market (recommended): The easiest way to buy a leveraged token is on its spot market.

How Do Leveraged Tokens Rebalance?

Every day at 00:02:00 UTC the leveraged tokens ‘rebalance’.  That means that each leveraged token once again reach its target leverage. Every day each leverage token reinvests profits if it made money.  If it lost money, it sells off some of its position, reducing its leverage back to 3x in order to avoid liquidation risk.

In addition, any token will rebalance if an intraday movement exceeds the given threshold value to reach back its target leverage.

This means that leveraged tokens can give up to 3x leverage without much risk of liquidation.  It would require a 33% market move to liquidate a 3x leveraged token, but the token will generally rebalance within a 6-12% market move, reducing its risk and returning to 3x leveraged.

What Are Leveraged Tokens’ Performance?

Daily Move

Each day, leveraged tokens will have their target performance; so for example, each day (from 00:02:00 UTC to 00:02:00 UTC the next day) ETHBULL will move 3x as much as ETH.

Multiple Days

However, over longer time periods leveraged tokens will perform differently than a static 3x position.

For instance, say that ETH starts at $200, then goes to $210 during day 1, and then to $220 during day 2.  ETH increased 10% (220/200 – 1), so a 3x leveraged ETH position would have increased 30%.  But ETHBULL instead increased 15% and then 14.3%.  On day 1 ETHBULL increased the same 15%.  Then it rebalanced, buying more ETH; and on day 2 it increased 14.3% of its new, higher price, whereas a 3x long position would have just increased another 15% of the original $200 ETH price.  So during this 2-day stretch, the 3x position is up 15% + 15% = 30%, but ETHBULL is up 15% from the original price, plus 14.3% of the new price–so it’s actually up 31.4%.

This difference comes because the compounded increase on a new price is different from moving up 30% from the original price.  If you move up twice, the second 14.3% move is on a new, higher price–and so it’s actually a 16.4% increase on the original, lower price.  In order words, your gains compound with leveraged tokens.

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Rebalance Times

Leveraged tokens’ performance will be 3x the underlying performance if you’re measuring since the last rebalance time.  In general leveraged tokens rebalance every day at 00:02:00 UTC.  This means that the trailing 24h moves might not be exactly 3x the underlying performance, rather the moves since midnight UTC will be.

In addition, leveraged tokens that are over leveraged rebalance whenever their leverage reaches 33% higher than its target.  This happens, roughly, when the underlying asset moves roughly 11.15% for BULL tokens, 6.7% for BEAR tokens, and 30% for HEDGE tokens.  So in fact the leverage token performance will be 3x the underlying asset since the asset last moved 6-12% that day if there was a large move and the token lost to it, and since midnight UTC if there wasn’t.

The Formula

If the movement of the underlying asset on days 1, 2, and 3 is M1, M2, and M3, then the formula for the price increase of the 3x leveraged token is:

New Price = Old Price * (1 + 3*M1) * (1 + 3*M2) * (1 + 3*M3)

Price movement in % = New Price / Old Price – 1 = (1 + 3*M1) * (1 + 3*M2) * (1 + 3*M3) – 1

When Do Leveraged Tokens Do Well?

Obviously the BULL tokens do well when prices go up, and the BEAR tokens do well when prices go down.  But how do they compare to normal margin positions?  When does BULL do better than a +3x leveraged position, and when does it do worse?

Reinvesting Profits

Leveraged tokens reinvest their profits.  That means that, if they have positive PnL, they’ll increase their position size.  So, comparing ETHBULL to a +3x ETH position: if ETH goes up one day and then up again the next, ETHBULL will do better than +3x ETH, because it reinvested the profits from the first day back into ETH.  However, if ETH goes up and then falls back down, ETHBULL will do worse, because it increased its exposure.

Reducing Risk

Leveraged tokens reduce their risk if they have negative PnL to avoid liquidations.  So, if they have negative PnL, they’ll reduce their position size.  Comparing ETHBULL to a +3x ETH position again: if ETH goes down one day and then down again the next, ETHBULL will do better than +3x ETH: after the first loss ETHBULL sold off some of its ETH to return to 3x leverage, while the +3x position effective became even more leveraged.  However, if ETH goes down and then back up, ETHBULL will do worse: it reduced some of its ETH exposure after the first loss, and so took less advantage of the recovery.

Example

As an example, comparing ETHBULL to 3x long ETH:

Summary

In the above cases, leveraged tokens do well–or at least better than a margin position that starts out the same size–when markets have momentum.  However they do worse than a margin position when markets mean-revert.

A common misconception is that leveraged tokens have exposure to volatility, or gamma.  Leveraged tokens do well if markets move up a lot and then up a lot more, and poorly if markets move up a lot and then back down a lot, both of which are high volatility.  The real exposure that they have is primarily to price direction, and secondarily to momentum.

What do Leveraged Tokens hold?

Leveraged Tokens hold perpetual futures.  That means that they will get their exposure to the underlying assets through the perpetual futures.  That also means that they will be subject to the price movements, premiums, funding rates, etc. of the perpetual futures.

Disclaimer:

1. The content above does not constitute any investment advice. Please be cautious of the risks. 

2. While your account‘s holding of a leveraged token cannot be liquidated, the leveraged token itself theoretically could be.  Leveraged tokens greatly reduce the risk of liquidation but cannot make it fully impossible; if markets instantaneously gap down 50%, there is nothing that can stop the +3x leveraged position held by the leveraged token from getting liquidated. In addition, while leveraged tokens attempt to avoid getting liquidated, this does not prevent them from being able to suffer heavy losses.

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