How do Leveraged Tokens Work on Binance? - FX Leaders FX Leaders

How do Leveraged Tokens Work on Binance?

Leveraged tokens are a collection of perpetual contract positions, with the token’s price tied to changes in the perpetual contract market. As a result, changes in the perpetual contract market have an impact on traders’ leverage positions.

Leveraged tokens provide you with leveraged exposure to a cryptocurrency’s price without the risk of liquidation. This way, you can benefit from the increased profits that a leveraged product can provide while not having to deal with the hassles of managing a leveraged position. This means you don’t have to manage collateral or margin requirements, and there’s almost no risk of liquidation.

Derivatives exchange FTX introduced the original leveraged token idea. These tokens have generated a great deal of discussion, in part because they don’t function as you might anticipate over the long run. The Binance Leveraged Tokens (BLVT) put forward a different layout.

Binance Leveraged Tokens (BLVT)

Binance Leveraged Tokens (BLVTs) are assets that can be traded on the Binance spot market. Each BLVT is a collection of open positions on the perpetual futures market. As a result, a BLVT is essentially a tokenized representation of leveraged futures positions.

The first BLVTs to be released are BTCUP and BTCDOWN. When the price of Bitcoin rises, BTCUP seeks to generate leveraged gains, whereas BTCDOWN seeks to generate leveraged gains when the price of Bitcoin falls. These leveraged gains range from 1.25x to 4x. In the following chapter, we’ll look at why this is the case and how they plan to use this leverage.

You cannot withdraw Binance Leveraged Tokens to your own wallet at this time; they can only be listed and traded directly on Binance. Be aware that Binance Leveraged Tokens are not created on the blockchain.

What is Binance Leveraged Tokens used for?

The basic objective is to stop front-running. Other traders could be able to profit from this well-known event if these tokens rebalance at regular intervals. The tokens are not required to rebalance unless the market conditions judge it appropriate because the goal leverage is not constant. As a result, these methods are lessened by masking the goal leverage because traders cannot predict the rebalancing events.

On the Binance spot market, leveraged tokens can be bought and sold. They can also be exchanged for the value they stand for. You will have to pay a redemption charge in this situation. However, you will typically be better off reducing your position rather than redeeming it on the spot market. Unless a black swan event occurs, exiting through redemption will normally be more expensive than exiting on the spot market. This is why selling your BLVT position on the spot market is nearly always advised.

Unless a black swan event occurs, exiting through redemption will normally be more expensive than exiting on the spot market. This is why selling your BLVT position on the spot market is nearly always advised.

The fact that BLVTs do not attempt to maintain constant leverage is one of the primary distinctions between BLVTs and other varieties of leveraged tokens. The target range of variable leverage is what they instead aim for. The goal is to reduce the danger of liquidation during price declines while maximizing possible returns during price increases.

Volatility Drag

Volatility drag is a concept that causes a lot of confusion when it comes to leveraged tokens. In layman’s terms, volatility drag is the negative impact that volatility has on your investment over time. The greater the volatility and the longer the time horizon, the greater the impact of volatility drag on leveraged token performance.

When there is a strong trend and market momentum is high, leveraged tokens generally perform as expected. In a sideways market, however, this is not the case. Binance invented variable leverage to address this issue. BLVTs only rebalance during times of extreme volatility and are not required to rebalance on a regular basis. While this does not completely solve the problem, it does significantly reduce the long-term consequences.

Should You Hold Leverage Tokens For The Long Term?

The most misunderstood goods in the cryptocurrency sector are frequently leveraged tokens. These tokens are effective funds that leverage an underlying asset’s profits through derivatives. A leveraged token often offers a multiplication of the daily return of an index or a particular asset. For instance, a 3x Long BTC will produce three times as much daily profit as Bitcoin.

The keyword to keep in mind here is DAILY. Leveraged tokens are designed to increase the underlying asset’s daily return. A token’s leverage factor will be reset daily. As a result, over time, a token’s performance may diverge from that of its underlying asset.

While comparing daily and total returns may appear trivial, the math behind them differs. Even a non-leveraged portfolio that loses 10% one day will not be able to break even with a simple 10% increase the next day. A $100 investment that loses 10% in a single day is worth $90 at the end of the day.

However, if the price rises 10% on the second day, the price will have risen 10% from $90 to $99. Clearly, the math did not add up as expected.

This real-world example demonstrates why leveraged tokens are not a good long-term investment. It shows how daily rebalancing and leveraging can cause performance variations over time. As a result, under certain conditions, leveraged tokens may not closely track their underlying asset.

Why Leverage Tokens Don’t Work the Way You Expect

Here’s an example of a 3x Long BTC token with a $100 starting value for the Bitcoin index and a $100 starting value for the token’s NAV.

Assume the Bitcoin Index dropped 10% on Day 1. This means that the index ends at $90 and the token ends at $70. So far, so good, don’t you think?

On Day 2, the Bitcoin index recovers 15% and closes at $103.50. The index is now 3.5 percent higher than its starting point.

Given that, the 3x token is expected to close at $110.50, or 10.5 percent higher than its starting price — three times the two-day average index return of 3.5 percent.

In fact, the token closes at $101.50, or 1.5 percent higher than its starting point. This is because the leveraged token increased the underlying index’s regular return by 3x to 45 percent (3x 15 percent). Its NAV rises from $70 to $101.50 as a result.

Let us now assume that on Day 3, our hypothetical Bitcoin index falls by 5% to $98.33. On a cumulative basis, it is 1.7 percent lower than its starting point.

In fact, the leveraged token would fall to $86.28, which is three times the index’s Day 3 return of 5%. Over the last three days, the token has dropped 13.7 percent.

Impact of Daily Rebalancing

Many investors are unaware that leveraged tokens are rebalanced on a daily basis. Regular rebalancing increases or decreases exposure while maintaining the fund’s purpose. As the fund reduces its index exposure, it sells derivatives positions by locking in losses, resulting in a lower asset base. This erosion will have an effect on investors’ initial investment in the token over time.

Volatility is your worst enemy because leverage must be reset daily. This may appear to be contrary to popular belief.

In most cases, volatility is a trader’s best friend. However, it is clearly not the case with leveraged tokens. Volatility has the capability to destroy you. This is due to the fact that daily returns will compound, giving an unanticipated mathematical result.

Even if the benchmark is flat at the end of the year, the token would lose value over time in proportion to how volatile the underlying index or asset is. If you bought and held a leveraged token over time and the index saw significant ups and downs, it might eventually lose a significant amount of value.

What you Need to Know When Trading Leveraged Tokens

For short-term trades, use leveraged tokens. If you hold leveraged tokens for an extended period of time, you may face negative consequences from the token’s daily rebalancing, which will reduce your performance returns.

Concentrate on markets that are strongly trending. Leveraged tokens outperform in markets with strong trends and momentum. To increase the likelihood of profit in your trade, make sure these factors are in your favor.

Leveraged tokens should be used to supplement exposure in your core portfolio. Leveraged tokens are not a replacement for holding spot-market assets. They do, however, provide additional opportunities for traders to gain exposure and profit in short-term trends.

How to buy Binance Leveraged Tokens

The top bar of the Binance home page has a link to the Leveraged Tokens page. The procedures for purchasing Binance Leveraged Tokens are listed below (BLVTs).

  • Register with Binance.
  • Select Leveraged Tokens by hovering your cursor over Derivatives in the top bar.
  • Choose the BLVT trading pair that you want to use.
  • This will direct you to BLVT’s landing page.
  • You will be directed to the Advanced trading interface after clicking Buy.

Please read the Risk Disclaimer before proceeding. Check the box and press the Confirm button to proceed if you are over the age of 18 and agree with the statement. At this stage, trading BLVTs should be comparable to trading other coins and tokens.

About the author

Skerdian Meta // Lead Analyst
Skerdian Meta Lead Analyst. Skerdian is a professional Forex trader and a market analyst. He has been actively engaged in market analysis for the past 11 years. Before becoming our head analyst, Skerdian served as a trader and market analyst in Saxo Bank's local branch, Aksioner. Skerdian specialized in experimenting with developing models and hands-on trading. Skerdian has a masters degree in finance and investment.