Leveraged tokens are a relatively new, and still controversial, asset class. They’re a hybrid between cryptocurrency and derivative trading that allows investors to trade the price rise and fall of individual cryptocurrencies.
While leveraged tokens have been around since 2018, they’re still not well understood by most people who invest in cryptocurrencies. That’s why we’d like to take some time to explain what these instruments are, how they work, and what pitfalls you should avoid when trading them.
What Are Leveraged Tokens?
Leveraged Tokens are a new asset class that has emerged from the blockchain boom. They are similar to traditional stocks in that they represent a stake in a company, but have a more complex structure than traditional equities and commonly include multiple different token types.
The smallest unit of account in most leveraged tokens is the singular share, which represents ownership of 1/100th of the company’s outstanding token supply. Most exchanges will allow a user to trade small quantities of shares for free or at a very low cost, allowing even small investors to move in and out of positions just like larger players.
In addition to tradable shares, most leveraged tokens include two other types of tokens: debt tokens and equity tokens. Debt tokens represent IOUs from the company to its holders and will accrue interest at a fixed rate until they are paid off by the company in future offerings.
Equity tokens represent shares in the company’s profits and will also accrue interest if it is able to make any distributions. Some leveraged tokens add a third type of token: dividends tokens, which give their holder some fractional ownership in the cash flows of the company’s products or services.
How Do Leveraged Tokens Work?
Leveraged tokens are a relatively new phenomenon, but they’re already making waves in the crypto space.
The basic idea behind these tokens is simple: you invest money into a token that has been designed to provide higher returns on your investment than traditional cryptocurrencies or pairs such as SHIB/USDT and BTC USDT.
In order to accomplish this goal, there must be some mechanism in place that allows for investors who have lost money on their investments (i.e., bad luck) to be able to regain their losses by earning back some of what they’ve lost from those who were lucky enough not to lose anything (i.e., good luck). This process is known as “rebalancing” or “leverage adjustment.”
Uses of Leveraged Tokens
Businesses and marketers can use these “Leverage Tokens” to drive their users’ cultural activities, like sharing media and buying products. Leverage Tokens are more than just the product itself. When used in the right way,
Leverage Tokens can attract multiple types of audiences and convert them into active participants in the business’s ecosystem. They can also be used to promote real-time engagement and create a sense of urgency via contests, promotions, and social sharing.
Putting tokens into the hands of consumers is easier said than done. The consumer may not have any clear idea of how they’re going to use or redeem their tokens, leading them to abandon them altogether. In order for tokens to be effective as leverage tools, businesses need to make it easy for consumers to understand how they work, what they mean, and how they can be used.
Overall, leveraging tokens can help businesses reach a wider audience by creating incentives for consumers to interact with the business’s brand or ecosystem.
The Rebalancing Mechanism
The rebalancing mechanism is one of the most important features of any leveraged token. It’s what allows you to get more out of your investment, but it can also be dangerous if you don’t understand it.
The best way to think about a rebalancing mechanism is that it’s like a buyback in traditional stocks: it helps maintain stability by removing tokens from circulation when prices go up or putting them back into circulation when prices go down.
A buyback only happens at one price–the current market price–whereas a rebalancing mechanism will always act on behalf of its users instead of just one party.
Mistakes To Avoid in Using Leverage Tokens
Holding Leveraged Tokens Long-Term
If you’re in it for the long haul, there are a couple of things you should do to make sure you’re holding the right leveraged tokens. Long-term investments are generally less risky and more profitable than short-term, but they require that you keep your eyes on the horizon and not get shaken out by quick downturns or even flash crashes.
To prepare for the long haul, it’s important to make sure that:
- You hold a diverse portfolio of tokens with different use cases and business models
- You only invest in projects with a community that will stick around after price fluctuations
- You understand the fundamentals of your investment and have done your research on technical analysis
Neglecting the Effects of Volatility Decay
Volatility decay is the process by which your position’s value decreases over time. It’s similar to the principle of compound interest, but with a twist: instead of earning interest on your gains (or losses), you’re losing small amounts each day due to volatility decay. In other words, if you own 100 tokens and their price drops from $1 each to 50 cents each over a month, then at the end of that period you’ll have only 50 tokens left–not 150.
This sounds like bad news…and it can be if you don’t know how to manage volatility decay properly.
If you’re trading leveraged tokens such as bitcoin futures contracts or margin trades on BitMEX, then understanding this concept will help ensure that your account doesn’t suffer unnecessary losses due to its impact on positions held overnight or over longer periods of time.
Disregarding the Effects of Rebalancing
Rebalancing is a risk-management strategy. It is not a way to make money, or trade, or lose weight, or sleep better.
While rebalancing is a necessity to maintain any kind of portfolio, traders need to be aware that it also consumes opportunity cost. When you rebalance your portfolio, you’re giving up some potential return in the future.
This means that if you would have made 10% per year on your initial investment instead of spending the money on rebalancing, you’d make even more than 10% per year on the reinvested returns. Some people might not think this is much of a loss, but it can be a very big deal when they’re talking about sums of money in the thousands or millions.
Letting Losers Run
Letting losers run is a common mistake. It’s tempting to hold on to losing positions, but it can be costly. If you want to stick with a losing position, make sure you have a good reason for doing so.
It’s okay to take a small loss and move on, but don’t let a loser run and lose so much that you can’t take a profit on another trade in the future.
Not Using Trend Trading
Trading leveraged tokens is all about identifying trends and taking advantage of them. Trends are easy to spot, but they can be difficult to trade because they move so quickly. If you’re not careful, you could get caught in a losing trade and lose your entire investment.
There are some key strategies that traders use when trading trends:
- Identifying the trend by looking at technical indicators like moving averages or Bollinger bands
- Using stop losses (or trailing stops) so that if the price moves against you, your position gets closed automatically without having to manually exit at market price
- Capitalizing on volatility decay by keeping trades open for longer than usual
