A leveraged token is a token with a leverage function and a derivative product designed to provide an investment return based on the leverage multiple of the underlying asset. Like general tokens, leveraged tokens can be bought and sold by users in the spot market, and each leveraged token corresponds to a perpetual futures position. The price of leveraged tokens will always follow the price changes in the futures market, and consequently, the rise and fall of the leverage level.
Unlike leveraged trading, you can enter a leveraged position without requiring any collateral, maintaining margin, and worrying about the risk of liquidation. Although users do not need to worry about liquidation risk, the risk exposure of leveraged tokens is derived from perpetual futures, which also means that leveraged tokens will be affected by factors such as price changes, premiums, and funding rates of futures.
So, what exactly are leveraged tokens, and should you invest in them?
What are leveraged tokens?
In investment, leveraged or margin buying is a way to amplify your investment returns or losses by borrowing money. Leveraged tokens allow cryptocurrency traders to use leverage without dealing with complex transaction processes, such as mortgage or liquidation. Liquidation is a way for traders to deduct margin when the loss is more significant than their investment. Leveraged tokens can reduce the liquidation risk of investors by rebalancing.
Not only can investors multiply their trading returns, but they can also bet on falling (short) or rising (long) prices. These are complex products, but they are also ordinary tokens that can be bought and sold on the blockchain. Their management methods and the names of the tokens vary from platform to platform.
Writing on trading website The Ascent, Lyle Daly provides a simple example: “A leveraged token allows you to take a leveraged position in a cryptocurrency, meaning your earnings or losses are multiplied. For example, a token called 3X Long Ethereum Token (ETHBULL) triples the profits of an Ethereum investment. So, if Ethereum increases by 1%, ETHBULL’s value increases by 3%. It works the same way if Ethereum decreases in price. Leveraged tokens may in principle seem easy to use, but they are still complex products. The following are some things you need to know before buying leveraged tokens.
The rebalancing mechanism will have a significant impact on prices
The rebalancing mechanism is a way of programming these tokens to automatically increase or decrease their positions, maintain target leverage, and avoid liquidation. Many tokens are rebalanced daily, which means they buy or sell at a set time to increase or decrease leverage. If the asset price changes dramatically, the tokens can also be automatically rebalanced. Understanding how and when your token is rebalanced is important because it works differently on different exchanges.
“Each leveraged token has a target leverage, such as three times the underlying asset. To maintain that leverage, the token will rebalance automatically. If it makes money, those profits will be reinvested. If it loses money, it will sell some of its position. Leveraged tokens typically rebalance every day. The exchange that offers the token may also have triggers that cause it to rebalance as soon as possible during periods of high volatility,” cautions Daly.
Leveraged tokens are short-term investment products.
Assuming you buy and hold ETH, and the price rises over time, you will profit no matter what happens in the market every day. However, if you buy and hold ETH3L tokens (ETH3L is a leveraged token that goes 3x long the ETH via futures trading), it will magnify the impact of any price changes, resulting in high costs. In addition, because of the decline in volatility, leveraged tokens will become more extreme for volatile assets such as cryptocurrencies.
Another reason to consider leveraged tokens as a short-term investment tool is that you must pay daily management fees. Although these costs may not seem high, if they are added up, it is not a small expense. Those may seem small when you look at them as daily rates, but you over the course of a year these fees soon add up.
Is it worthwhile to invest in leveraged tokens?
If you are considering buying leveraged tokens, then BigONE recommends that you fully understand their working principles and risks before purchasing. These are advanced trading products designed for more experienced investors.
Not only do you need to understand the ins and outs of leveraged tokens, but you also need to know how to rebalance the platform you plan to use. For example, when the crypto market suffered considerable losses in May, investors in leveraged tokens lost a lot of money. Although investors have shorted and bet on falling prices, rebalancing the system means that their tokens are still depreciating.
Attempting to participate in the market through short-term transactions is always more challenging than a long-term investment. Leveraged tokens are a short-term investment method like turbocharging a car. For many investors, a better approach is to spend time researching currencies that you think will perform well in the next five to ten years. However, even if you look at it from a long-term perspective, you should only invest money that you can afford to lose so that you will not lose sleep due to daily price fluctuations and so that it won’t negatively impact your finances.