What are Leveraged Tokens?
Leveraged tokens are crypto tokens that enable traders to carry out leveraged trading without dealing with complicated trading aspects like collateral, liquidation and margin. With these tokens, traders can gain access to cryptocurrency assets in a less complex way. However, these tokens are not for holding as they provide fixed as well as variable leverage.
How do Leveraged Tokens Work?
Although leveraged tokens are bought and sold like regular coins, they work quite differently from regular tokens and coins. Leveraged tokens lets investors multiply their trade profits by either betting on the price going up (going long) or going down (shorting).
Therefore, when the price of the underlying asset changes, the leveraged token price changes based on the leverage.
To give a better picture of how leverage token trading works, let’s say you are holding a BTCUP3X token and its price is $250. The leverage here is 3X. When the price of bitcoin goes up by 3%, you make a profit of $9 (3×3%) and if the price of the coin goes down by 3%, you’ll lose $9 (3×3%).
Basically, for each 1% Bitcoin increases in a day, BTCUP3X token increases by 3%, and for every 1% Bitcoin decreases, BTCUP3X decreases by 3%.
4 Things You Need To Know Before Buying Leverage Tokens
1. Leverage Tokens are short-term investments for experienced traders
The volatile nature of cryptocurrency is even more prominent when dealing with leverage tokens. This means if you hold on too long to leverage tokens, you may likely lose money.
As a trader, purchasing leverage tokens is a principal investment to make if you are at least 95% sure that there will be a rise or fall in the underlying coin price soon. For instance, if you’re confident Bitcoin price may rise soon, purchasing a BTCUP3X token can bring you a huge profit - if your prediction is right.
Dealing with leverage tokens requires an expert level of experience in crypto trading because the risks involved are highly significant. Your investment can take a huge hit with the same speed at which it can receive a huge boost.
If you are new to crypto trading and investing, it is advisable to steer clear of trading with leverage tokens until you have gathered enough experience, knowledge and capital to spare.
2. They're susceptible to volatility decay
One of the biggest risks of leveraged tokens is volatility decay, or the negative impact of volatility on the investment. The best way to understand this concept is with a comparison.
Volatility decay refers to the negative effect of volatility on an investment. To explain this concept better, let’s say you buy $100 worth of ETH Two days after, the price of ETH goes up by 10%, making your investment worth $110. Then the next day, the coin price drops by 10%, which is an $11 drop in this case, making your investment worth $99.
Now, if you had used those $100 to buy an ETH leveraged token that triples the coin profits. That would mean a 30% increase two days after your purchase, which would be $130. However, it would also be a 30% loss the next day when the coin drops in price, costing you $39 and leaving you with $91.
In simple terms, leveraged tokens makes your investment more susceptible to volatility decay and bigger profit losses.
3. Rebalancing typically affects price heavily
Rebalancing is the manner in which the positions of leverage tokens are automatically programmed to decrease or increase in order to avoid liquidation issues and maintain the target average. For instance, if the price of Bitcoin changes, the BTCUP3X token might have to sell or buy BTC to keep its 3x position.
Most tokens are rebalanced daily. This means that at a stipulated time, they sell or buy to increase or decrease leverage. Token rebalancing can also happen automatically if the asset price changes drastically.
4. Leveraged tokens are a simple way to trade leverage
Margin or leveraged trading is typically complicated and needs constant management. As a crypto trader, leveraged tokens gives you the opportunity to dive into leverages with less work and complexity.
You also don’t have to worry about margin (money borrowed from a crypto exchange) or collateral when trading leverage tokens. There is also less potential for liquidation because of the rebalancing process; even in situations where the token falls in value, it will sell off some of its position to ensure it is not cleared out.
If you are a crypto trader with a lot of market experience or an investor with a high risk appetite, leveraged tokens are a smart simple way to get into leveraged trading without committing too much.
However, if you are new to crypto trading or you don’t have much experience, leverage tokens should not be a trading option for you just yet. Try out other trading strategies like spot trading and day trading while doing more research on leveraged trading/leveraged tokens. If you still want to try leveraged tokens, do well to start your investment with a small amount of capital.
Disclaimer: This article was written by the writer to provide guidance and understanding of cryptocurrency trading. It is not an exhaustive list and should not be taken as financial advice. Obiex Finance will not be held liable for your investment decisions.