Leveraged tokens from FTX and MARKET Protocol allow investors to hold an asset with integrated leverage. While this seems risky on the surface, they can provide superior capital appreciation during sustained trends.
From Leveraged ETFs to Leveraged Tokens
Tokenization has the potential to change finance through new services, but they can also recreate traditional efficiencies with ease. In this particular case, the concept of a leveraged ETF has been brought to the cryptocurrency industry.
A leveraged ETF allows an investor to purchase units in an index fund with more exposure than they can afford. Most leveraged ETFs trade on 3x leverage. This means an investor can use $100 to buy a position worth $300.
FTX offers tokens with 3x leverage as well. But what exactly is the difference between using perpetual swaps to go long on, say, ETH/USD with the same amount of leverage?
Su Zhu and Andrew Kang, two well-known analysts with expertise in derivatives and market structures, ran an experiment to showcase how leveraged tokens work and when they can be a useful tool in a trader’s arsenal.
Their experiment involves comparing a 3x leveraged long position and a 3x short position on the ETH/USD trading pair with the ETHBULL and ETHBEAR tokens on FTX respectively.
At first glance, both of them look the same. However, leveraged tokens rebalance on a daily basis so that the daily profit is used to acquire more ETH, which is added to the initial capital pool.
And because the base pool has inflated, the same 3x leverage translates to a higher exposure of ETH.
Visible from the experiment, profits in the leveraged token strategy are used to increase the base amount of ETH.
The unleveraged exposure rises from $10,000 to $13,000. Using 3x leverage, exposure should now be $39,000, which translates to 433.33 ETH at a price of $90 per ETH.
In short, leveraged tokens can offer investors great returns in times of momentum. When a market is trending in a particular direction, leveraged tokens will outperform spot and derivatives contracts.
These instruments work best in trending markets as they continuously increase an investor’s net exposure.
An important point of note is that of “beta slippage.”
This is a situation in which the leveraged counterpart is at a higher price than the spot price. When the spot price falls, the leveraged token falls by a greater percentage because it started at a higher base and has integrated leverage.