A Beginner’s Guide to Leveraged Tokens

Copied to clipboard!
A Beginner’s Guide to Leveraged Tokens
Listen to this article
00:00 / 00:00


What are leveraged tokens?

Leveraged tokens are innovative assets that can give you leveraged exposure to cryptocurrency markets, without all the nitty-gritty of managing a leveraged position. Most leveraged tokens are ERC-20 tokens issued on the Ethereum blockchain. They were initially introduced by derivatives exchange FTX, but since then have been listed on many other exchanges, including Binance

The idea is that you can get into a leveraged position without having to worry about collateral, margin, funding rates, or liquidation. It should be noted, though, that leverage tokens may lose significant value in a sideways or zig-zag market, and are generally not intended for long-term holding. So make sure you understand the mechanisms before exposing yourself to financial risk.

Since leveraged tokens are on a blockchain, they allow similar functionality as other tokens. This means that you can buy, store, and transfer them like any other token while having leveraged exposure to the underlying asset.

For example, consider BULL, the token that represents a 3x long exposure to the price of Bitcoin. If the price of Bitcoin goes up 1%, BULL goes up 3%. Conversely, if Bitcoin goes down 1%, the price of BULL goes down 3%.

The inverse of the BULL token is the BEAR token, which represents a 3x short exposure to the price of Bitcoin. As such, if the price of Bitcoin goes down 1%, the BEAR token goes up 3%, while if Bitcoin goes up 1%, BEAR goes down 3%.

The idea behind any leveraged token is essentially the same, but for different tickers and leverage. The currently available leveraged tokens on Binance are BULL and BEAR tokens for BTC, ETH, BNB, XRP, and EOS, respectively. Each of them represents a 3x long or short exposure to the underlying cryptoasset.

How do leveraged tokens work?

Each leveraged token represents leveraged exposure. These tokens can be issued and redeemed through FTX but can be traded on other markets, like any other ERC-20 token.

Let’s say you’d like to issue 100 USD worth of ETHBULL, the token that represents a 3x long exposure to ETH. You send 100 USD to issue the token, and the account that represents the token will open a 300 USD position on the ETH/USD perpetual futures market. Think of this account as a trading bot that takes care of your leveraged position for you.

So, the account now has a 300 USD long position on the ETH/USD futures market, which is represented by your 100 USD worth of leveraged tokens.

The same process applies not only for issuance but for redemption as well. Similarly to how a stablecoin can, in theory, be redeemed for the value it represents, leveraged tokens can also be redeemed for the value they represent. 

If you’d like to destroy your 100 USD worth of ETHBULL tokens, here’s what happens. The account that represents the token will close the open position worth 300 USD on the ETH/USD perpetual futures market, and you’ll get your 100 USD back. This issuance and redemption mechanism is what ultimately should keep the price of leveraged tokens at the intended levels.

Of course, if you’d just like to trade the leveraged tokens, you don’t have to worry about the issuance and redemption processes. You can just simply buy and sell them like any other token.

In fact, the creation and redemption process is only recommended for advanced traders, as it can be a bit complicated. Even so, understanding how the process works is important to be able to use the tokens more effectively. 

How do leveraged tokens rebalance?

Now that we understand how they work, let’s talk about how they achieve the target leverage. Every day, at 00:02:00 UTC, the accounts that represent the tokens rebalance. This means that they either buy or sell assets on the perpetual futures market to achieve the target leverage for that day. So, if they made money, they reinvest profits (buy) to increase their leverage. If they lost money, they sell some of their position to decrease their leverage.

In addition, the tokens also rebalance if the target leverage is considerably higher than the intended leverage. For example, if ETH moves down 11% in less than a day, ETHBULL will rebalance before the usual rebalance date to prevent liquidation. This means that there’s little risk of liquidation, as the tokens should automatically rebalance in times of high volatility.

Before we go further, let’s reiterate a key detail. Under normal circumstances, the tokens rebalance once each day. During times of high volatility, the tokens also rebalance to prevent liquidation. This means that the target leverage is achieved since the last rebalance, but not at all times. As such, leveraged tokens might perform very differently from a simple leveraged exposure, especially at times of high volatility.

Are you at risk of liquidation?

While there’s virtually no chance that your account holding these tokens is going to be liquidated, the tokens themselves could be. The rebalance process we discussed earlier can’t account for all scenarios. If the market instantaneously gaps down 50%, the tokens might not have a chance to rebalance. What does this mean for you as a leveraged token holder?

You won’t be liquidated of your token holdings, but they could experience extreme price moves. For example, in March 2020, the price of Ethereum dropped around 50% in the span of roughly a day. During that time, the ETHBULL token lost about 95% of its value.

chart visualizing extremely volatile conditions

As you can see, it’s extremely important for you to understand the risks of holding these tokens.

How to buy leveraged tokens

You can buy leveraged tokens in the same way as you would any other token listed on Binance.

  1. Log in to your Binance account. If you don’t have one, register, and create one in minutes. 
  2. Click on Markets on the top bar.
  3. Select FIAT Markets.
  4. Search for the leveraged token you’d like to buy.
    list of leveraged token trading pairs on Binance
  5. Click on it, and start trading!

Looking to get started with cryptocurrency? Buy Bitcoin on Binance!

The advantages of leveraged tokens

Managing risk on leveraged positions can be a daunting task. With leveraged tokens, you don’t have to worry about margin, collateral, liquidation prices, and funding rates. You can just buy the tokens, and it’s all taken care of.

An additional advantage is that since these tokens exist on a blockchain, you can move them between exchanges or withdraw them to your own wallet. This makes leveraged tokens one of the few ways you can hold leveraged positions in a non-custodial way.

The risks of leveraged tokens

Leveraged tokens sound great. So why not use them only instead of futures or margin positions? Well, they are high-risk products that are fairly experimental, so they introduce some risks of their own.

The main thing to consider is that, over the long-term, leveraged tokens will perform differently than a simple leveraged exposure. Because of the rebalancing process we’ve discussed earlier, the target leverage will be achieved for each day (or since the last rebalance), but likely not over the long-term. As mentioned, leveraged tokens are not intended for long-term holding. So it might be worth comparing a leveraged token’s historical performance to that of a simple leveraged position before entering a longer-term trade.

Generally, leveraged tokens tend to work more predictably when market momentum is high and perform inconsistently when the markets are in a consolidation phase. But this too can vary, so it’s worth going over FTX’s advanced walkthrough to understand all the details.  

Another thing to consider is that these tokens tend to be traded with lower volume and liquidity than regular margin or futures markets.

Closing thoughts

The idea of programmable money has opened up new avenues not just for gaming, digital collectibles, and prediction markets, but also for trading.

Leveraged tokens are a recent innovation that let you enter leveraged positions in a way that’s very simple and easy to understand. Binance has listed a number of them that can give you 3x long or short exposure to selected cryptoassets.

If you’d like to read more on leveraged tokens, check out the guides on FTX.