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Leveraged tokens offer a way to build up larger positions in the cryptocurrency space. Essentially, they’re tokens that are designed to provide amplified returns on investment. As such, they can be attractive for investors looking to generate quick profits.
However, there’s also the potential for losses if things go wrong. So, what should you do when you come across leveraged tokens? In this blog post, we’ll explore what leveraged tokens are, how they work and which trading strategies might suit this product.
Leveraged tokens are a class of derivative instruments that magnify the returns (or losses) on an underlying asset via a leveraged position. They allow investors and traders to amplify their returns in the crypto market without requiring a high amount of collateral.
Here’s an example of how they work: If a trader buys BTC3L (long BTC with a 3x leverage), then any profit due to the price action of BTC is multiplied three times. However, if the price of BTC drops from the trade’s original position, the losses are also multiplied three times.
For instance, suppose this trader buys $10,000 worth of BTC3L. If the price of BTC jumps by 10%, the trader with the BTC3L token gains a 30% return. This means that the trader would gain $3,000, as opposed to $1,000, in the BTC market.
Leveraged tokens are a basket of perpetual futures, which are essentially contract positions without an expiration date. This means that traders can purchase a leveraged token and hold their positions for as long as they wish. Although anyone can buy leveraged tokens, they’re best utilized by experienced traders who can manage risks appropriately.
Another feature of leveraged tokens in cryptocurrency is that, depending on the token, you can profit from the gains or declines in the price of an underlying asset. For example, buying SOL3S (shorting SOL with 3x leverage) allows you to generate leveraged gains when the price of SOL goes down. On the other hand, buying SOL3L (long SOL with 3x leverage) allows you to make leveraged gains when SOL’s price increases. In that case, holders of the SOL3L token would make gains, while SOL3S holders would field losses.
One of the fundamental features of leveraged tokens is that they minimize the risk of liquidation, which is when positions are automatically closed out. Rebalancing helps them to maintain constant leverage on underlying assets.
All leveraged tokens target a specific leverage value (or range of values) that determines their exposure. Depending on the token, this may range from 2x to 4x. As price action occurs, due to market fluctuations, the exact leverage that a token has on an asset will change.
If the price of the underlying asset appreciates for a 3x leveraged token, its leverage may decrease to less than 3x, such as 2.8x or 2.5x. To maintain the target leverage of 3x, the exchange will rebalance by investing the profits on the asset into buying more positions in the market.
On the other hand, if the price of an underlying asset decreases, the leverage of a token increases, for example from 3x to 4x. This in turn, increases the possibility of liquidation: A 25% loss on BTC would wipe out holders of BTC3L if their leverage remains at 4x (since their losses would be amplified by a factor of 4). To ensure this doesn’t happen, the leveraged token will be rebalanced by having some of its positions sold off.
Leveraged Token Rebalancing
To make this clearer, let’s illustrate with an example.
If a 3x leveraged token has a net asset value (NAV) of $200 million, the value of its exposure in the underlying asset at the start of a trading day would be $600 million (or 3 × $200 million). If prices increase by 5%, the value of the exposure (and thus the leveraged token) will increase to $630 million. Likewise, the NAV will increase by $30 million to $230 million. When comparing the value of the leveraged token’s exposure with the NAV, it’s clear that they’re now unbalanced.
To return the leverage to its original value, the token would need to purchase an additional $60 million of exposure, taking the exposure to $690 million. This additional exposure will allow the asset’s owners to compound their profit as the leveraged token appreciates.
On some exchanges, rebalancing typically occurs at a specific time every day. With exchanges such as Bybit, rebalancing occurs when the leverage falls outside a target value. For example, with LTC2L on Bybit, rebalancing occurs when the leverage falls outside a range of 2x to 4x, or hits any of these threshold values.
Rebalancing may also occur if the market fluctuation is so extreme as to wipe out traders’ investments. An adverse price change of 33% can negate a 3x leveraged token’s NAV. Before something like this occurs, at a specific percentage change, the leveraged token can undergo intraday rebalancing to reduce the risk of liquidation.
As opposed to traditional holdings, such as spot trading, leveraged tokens offer unique advantages to traders who understand how they work. Some of these benefits include:
Opportunities for higher profits as you gain exposure to leveraged trading positions
Ability to trade from a leveraged position without the need to maintain as much collateral
Higher utility of funds, enabling you to generate increased profits from your capital
Easy-to-understand trading mechanisms that depend solely on the market
Ability to leverage the compounding effect to earn higher returns in a trending market
Reduced risk of liquidation in an unfavorable market
Algorithmic management of risk
Below are some of the risks of trading leveraged tokens:
Leveraged tokens can incur additional fees
Rebalancing can significantly affect the NAV of an asset holder’s tokens in a bearish market
Leveraged tokens are best suited to advanced traders
Leveraged tokens open asset holders to the potential of more significant losses than spot trading does
Leveraged tokens offer investors an opportunity to quickly multiply their gains by amplifying the effects of price action. For less experienced investors, this might seem like a good way to quickly make a buck. However, it’s important to note that the high volatility of leveraged tokens makes it very difficult to hold them for the long term. Cryptocurrencies are volatile enough, and the extra risk of amplified price action makes holding leveraged tokens risky.
A leveraged token is better utilized for short-term investments: You buy it in the hopes that the underlying cryptocurrency will rise or fall in price soon. Once the anticipated price action occurs, you can then take out your investment.
Holding a leveraged token long after an expected price has occurred can lead to elimination of your profits. For example, if you buy $2,000 worth of SOL3L, and the price of SOL moves up 10% in one day, you would gain $600 via a leveraged position, taking your portfolio to $2,600.
If, however, you fail to take profits and the market moves down 10% the next day, your SOL3L portfolio would lose $780 (or $260 × 3), falling to a value of $1,820. Thus, in the end, you would take a loss of $180.
Leveraged tokens also incur significant management fees, so it isn’t feasible to keep them for a long time. On our end, leveraged tokens have a daily management fee of 0.005%. Over the course of a year, this adds up to over 10% of your investment.
Leveraged tokens aren’t long-term investments; therefore, it’s important to go into such a trade with a suitable short-term trading strategy. Leveraged tokens yield traders the best gains in a one-sided market, which makes them best suited for short periods when the market is in a constant (often intraday) trend.
Since leveraged tokens are rebalanced often to maintain constant leverage, it can be difficult to predict their long-term performance. People new to trading leveraged tokens may be surprised to see that, after a while, they perform quite differently from their underlying assets.
Again, a leveraged token strategy is most effective with short-term trades that take advantage of intraday, one-sided price action. Work with momentum and price action, not against it. Your leveraged token strategy should help you identify the market's trend, and should include both an entry and exit strategy that help you maximize return.
Scalping is one of these strategies, helping you take advantage of smaller changes in price action to protect against loss and boost your profits. You’ll need to rely on your technical analysis of the underlying asset to determine when to enter and exit the market. The better the quality of your analysis, the more you’ll be able to maximize your profits.
As with other cryptocurrency assets, leveraged tokens are extremely volatile. Be sure to follow the basic rules of trading to minimize your financial risk while trading the market.
Bybit allows traders to take advantage of real-time price action to make winning trades. Bybit Leveraged Tokens are derivative products, with no margin required, that provide leveraged exposure to the crypto asset.
Trading Bybit Leveraged Tokens incurs the following fees, depending on what you do with your leveraged token:
Trading fees are charged when a trader buys or sells leveraged tokens in the Spot market. The rate is the same as typical Spot market fees: 0.1%.
Subscription fees are incurred when a trader decides to buy a leveraged token. The subscription fee rate is 0.05%.
A redemption fee is charged when a trader chooses to redeem their leveraged token. Redemption fees are set at 0.05%.
A management fee is charged daily by the exchange at 12AM UTC. Its value depends upon the size of a trader’s position in the market and the net asset value.
A funding fee is charged for Bybit Leveraged Tokens based on the funding rate of the underlying asset. Note that this fee is charged on the NAV of your tokens; your leveraged positions aren’t affected.
To find out more about trading fees on Bybit, see Bybit Leveraged Tokens: Fees Explained.
Here’s the step-by-step process for trading leveraged tokens on Bybit:
Tap Trade in the navigation bar, and select Leveraged Tokens from the drop-down menu.
Click on the leveraged token pair you want to trade.
If it’s your first time trading leveraged tokens, a Risk Alert pop-up will appear. Please read and understand the information in the pop-up box before clicking Acknowledge and Activate Token. If you have any questions, reach out to Bybit Live Chat for assistance.
Complete the security quiz that pops up on your screen. You’ll first need to answer all the questions correctly in order to trade.
Click on Submit Now. Once that's done, you can begin trading leveraged tokens on Bybit.
Leveraged tokens can be traded by anyone, just as with any other cryptocurrency derivative product. However, ideally they’re intended for experienced traders, who can harness trending markets and technical analysis to gain profits while minimizing their risk. Finally, the best way to maximize the benefits of leveraged tokens is to keep holdings for shorter-term trades.