Leveraged Tokens Explained: How Do They Work?

Welcome to this overview of leveraged tokens by FTX. We're going to explore what leveraged tokens are, why you should consider using leveraged tokens and when leveraged tokens perform best. So let's kick it off! What are leveraged tokens? Leveraged tokens are ERC20 tokens that have leveraged exposure to crypto. There are two different types of leveraged tokens available. 1x tokens are referred to as HEDGE. 3x tokens are referred to as either BULL or BEAR tokens. Let's take ETHBULL as our example. Remember, this is a 3x long ETH token. So, for every 1% ETH goes up in the day, ETHBULL goes up 3%. For every 1% ETH goes down, ETHBULL goes down 3%.

Each leveraged token gets its price action by trading FTX PERP Futures. For instance, if you create a $1000 worth of ETHBULL. In order to do that, you need to spend a $1000 and the ETHBULL account on FTX buys $3000 worth of ETH-PERP Futures. Thus, ETHBULL is now a 3x long on ETH. You can also redeem leveraged tokens for their net asset value (NAV). To do that, you can send your $1000 of ETHBULL back to FTX and redeem it. This will destroy the token, cause the ETHBULL account to sell back the $3,000 worth of futures and credit your account with the $1000. Ok, so why do you want to use leveraged tokens? Leveraged tokens will automatically reinvest profits into the underlying asset.

So, if your leveraged token position makes money, the tokens will automatically put on 3x leverage positions with that profit. Leveraged tokens will also automatically reduce risk if they lose money. So, if you put a 3x long position on ETH and over the course of a month ETH falls by 33%, your position will be liquidated and you will have nothing left. But instead if you were to buy ETHBULL, it will automatically sell off some of the ETH as the markets go down. Likely avoiding your liquidation, so that it still has assets left even after a strong 33% down move. When do leveraged tokens work best? BULL tokens do well when the price goes up, obviously.

And BEAR tokens do well when the prices go down. But how do they compare to normal margin positions? When does ETHBULL do better than a 3x leverage position? And when does it do worse? Let's explore in a little bit more detail. We covered this a little bit before but, leveraged tokens reinvest their profits. So that means that if you have a positive PNL, they will increase their position size.

So comparing ETHBULL to a 3x ETH position – If ETH goes up one day and then up again the next day, ETHBULL will do better than a 3x ETH position because it reinvested the profits from the first day back into ETH. However, if ETH goes up and then falls back down, ETHBULL will actually do worse, because it increased your exposure after the positive first day. Let's talk about reducing risk. Leveraged tokens reduce their risk if they have a negative PnL in order to avoid liquidation. So if they have a negative PnL, they'll automatically reduce their position size. So if we take the same comparison of ETHBULL to a 3x ETH position again – If ETH goes down one day and then down again the next, ETHBULL will perform better than a 3x ETH position.

This is because after the first loss, ETHBULL would have sold off some of its ETH to return to its 3x leverage. While the 3x position effectively became more leveraged. However, if ETH goes down and then back up, ETHBULL will do worse. It reduced some of its exposure after the first loss and so was unable to take advantage of the recovery. So let's summarize. In both cases leveraged tokens do well or better than a margin position that starts out the same size, when the markets have momentum.

Leveraged tokens and in this example BULL tokens, do well if the market moves up a lot and then up a lot more. They do poorly if the market moves up a lot and then back down a lot. Both of which are high volatility. The exposure that leveraged tokens have is to price direction and momentum. FTX – Built By Traders, For Traders.

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