Leveraged Tokens

Leveraged tokens are a type of cryptocurrency derivative designed to amplify the returns of an underlying asset, typically by using leverage. These tokens are structured to provide traders with leveraged exposure to assets like Bitcoin or Ethereum without requiring them to directly manage leverage positions.

For example, a 3x leveraged Bitcoin token aims to provide three times the daily returns of Bitcoin. So, if Bitcoin goes up by 1% in a day, the 3x leveraged Bitcoin token would ideally go up by 3%. Conversely, if Bitcoin drops by 1%, the leveraged token would ideally drop by 3%.

However, leveraged tokens are not meant for long-term holding due to their compounding nature. Their performance can deviate significantly from the underlying asset's performance over time, especially in volatile markets. This deviation is due to the daily rebalancing process required to maintain the target leverage ratio. As a result, leveraged tokens are more suitable for short-term trading rather than long-term investment.

An infamous case involving leveraged tokens occurred in March 2020 during the extreme volatility in the cryptocurrency markets caused by the COVID-19 pandemic. Many leveraged tokens suffered from significant losses and even faced liquidation events as the underlying assets experienced unprecedented price swings. This incident highlighted the risks associated with trading leveraged tokens, especially during times of extreme market turbulence.