Leveraged Tokens in Cryptocurrency Trading: From Operating Mechanisms to Hidden Risks

In today’s cryptocurrency market, traders are always looking for tools that allow them to amplify profits without bearing the liquidation risks typical of traditional margin trading. Leveraged tokens emerge as an attractive solution, but they also carry risks that not everyone fully understands. This guide will help you grasp how leveraged tokens work and important considerations when using them.

What Are Leveraged Tokens?

Leveraged tokens are cryptocurrency derivative products designed to provide amplified exposure to the price volatility of an underlying asset such as Bitcoin or Ethereum. Unlike traditional margin trading, these tokens are structured as standalone assets that you can buy and sell like any other cryptocurrency.

A simple example: if you invest $1,000 in a Bitcoin 3x long token, and Bitcoin’s price increases by 10%, your token’s value will increase by approximately 30%. Sounds appealing, but remember that if Bitcoin drops 10%, your token will lose 30%.

Difference From Traditional Margin Trading

Margin trading requires borrowing funds from an exchange or broker, using assets as collateral, and facing liquidation risks if prices move against you. You also need to constantly monitor your margin ratio.

Leveraged tokens eliminate these complexities by automating leverage management. You just buy and hold the token, without managing margin or worrying about margin calls. However, this simplicity comes at a cost: the token’s daily rebalancing mechanism can cause unexpected losses in volatile markets.

Rebalancing Mechanism: The Heart of Leveraged Tokens

Leveraged tokens maintain the desired leverage level through an automatic process called daily rebalancing. This is the most critical aspect to understand when trading these tokens.

Suppose you hold a Bitcoin 3x long token. If Bitcoin increases by 5% in a day, your token theoretically increases by about 15%. However, at the end of the day, the exchange will rebalance the position by selling part of the assets to bring the leverage back to 3x.

This mechanism seems reasonable, but it creates a problem known as “volatility decay” (suy giảm biến động). In a highly volatile market, daily rebalancing can lead to accumulated losses even if the price eventually returns to the initial level.

For example: if Bitcoin rises 10% and then falls 10%, the price will return to the original level. But your 3x leveraged token will not, because each rebalancing adjusts the leverage from the start.

Rebalancing Fees

Different platforms apply various fee structures for rebalancing. Some charge daily fees (0.01% per day, which can amount to up to 3.65% annually), while others do not explicitly charge fees but include costs within tracking performance.

You should carefully review each platform’s terms to understand actual costs. These fees can significantly erode your potential profits, especially during slow market growth periods.

Leveraged Tokens Compared to Other Trading Forms

Compared to Futures Contracts

Futures allow you to bet on future prices without owning the actual asset. You have full control over your position, can exit anytime, and are not subject to daily rebalancing mechanisms.

In contrast, leveraged tokens are pre-structured assets. You do not control the rebalancing process, which can work against you under certain market conditions. Futures are better if you want short-term trading with full control, but leveraged tokens are simpler if you just want to buy and hold.

Compared to Margin Trading

Traditional margin trading requires managing collateral assets and continuously monitoring margin requirements. With leveraged tokens, you don’t have these worries—you just buy the token like any other cryptocurrency.

However, with margin trading, you have full control over your position and can exit at any time. Leveraged tokens are bound by the rebalancing mechanism, which may not always be favorable.

Compared to Spot Trading

Spot trading is the simplest form—buying or selling assets at current prices. You have no leverage, so profits or losses are directly proportional to the asset’s price change.

Leveraged tokens offer amplified exposure but at the cost of volatility decay and potential rebalancing fees.

Who Are Leveraged Tokens Suitable For?

Leveraged tokens work best in a clear one-way market—continuously rising or falling without major reversals. In such conditions, the rebalancing mechanism benefits you by maintaining exposure to the main trend.

However, in highly volatile or uncertain markets, leveraged tokens can be a poor choice. Volatility decay can accumulate and wipe out your profits.

Benefits of Leveraged Tokens

Amplified profits: In a rising market, you can earn 2x or 3x returns compared to spot trading. If Bitcoin increases by 50%, your 3x token will increase by about 150%.

Simplified trading process: No need to manage margin, monitor margin calls, or worry about liquidation. Just buy and hold the token.

Access to multiple assets: These tokens are available for Bitcoin, Ethereum, and many other cryptocurrencies, allowing diversification.

Built-in risk management: Daily rebalancing helps prevent positions from becoming overly leveraged.

Risks of Trading Leveraged Tokens

Amplified losses: If the market moves against your position, losses are also amplified. A 50% drop in Bitcoin could lead to a 150% loss with a 3x token—meaning you could lose your entire investment.

Volatility decay: This is the biggest risk. In highly volatile markets, daily rebalancing can lead to cumulative losses even if the price doesn’t change much from the start. This effect is worse in markets with high volatility.

Accumulated fees: Daily management fees, though small, can amount to a significant percentage annually, eroding your profits.

Not suitable for long-term trading: Due to volatility decay, leveraged tokens are not ideal for long-term investing. Their performance can diverge from the underlying asset’s price over time.

Market liquidity: Liquidity of some leveraged tokens can vary, leading to high slippage or wide bid-ask spreads.

Platforms Offering Leveraged Tokens

Leveraged tokens were initially introduced by FTX, a now-closed cryptocurrency derivatives exchange. Since then, many other trading platforms have started offering similar products.

Currently, many major exchanges provide leveraged tokens for Bitcoin, Ethereum, and other popular altcoins. Each platform has its advantages:

• Some offer high liquidity with low slippage
• Others provide a broader range of assets
• Some have lower management fees than others

When choosing a platform, compare:

• Liquidity of the tokens
• Daily fee structure
• Range of available assets
• Platform reputation and security

Frequently Asked Questions

Do leveraged tokens get liquidated?

Not in the same way as traditional margin trading because they do not require maintaining margin. However, if the market moves against you or is highly volatile, the value of your tokens can decline significantly.

Are leveraged tokens suitable for long-term trading?

No. They are designed for short-term trading aiming at daily performance. Due to volatility decay, rebalancing, and fees, long-term performance can diverge from the underlying asset’s price.

How can I minimize risks when trading leveraged tokens?

• Trade leveraged tokens only for short-term positions
• Use them only in clear one-way markets
• Always perform thorough analysis before trading
• Be aware that volatility decay is the biggest risk

Conclusion

Leveraged tokens offer a way to amplify profits without managing the complexities of traditional margin trading. However, this simplicity comes at a cost: volatility decay, fees, and risks that can wipe out your entire investment.

They work best for traders who understand the associated risks, have good market analysis skills, and use them only for short-term trading in favorable market conditions. They are not suitable for long-term investors or those without experience with financial instruments.