Trading 101: Important Things to Know Before You Buy Crypto Leveraged Tokens

2021/08/26 10:42:39

The crypto derivatives market has tremendously grown over the past few years and now accounts for more than 54% of all crypto transactions. This growth has been primarily driven by the demand for leveraged crypto products that we see in the Forex and Stock markets. In this article, let’s discuss a few things you need to know before using the latest and most interesting crypto derivatives - the leveraged crypto tokens.

What are Leveraged Tokens?

Leveraged Tokens are leveraged crypto derivatives that you can invest in the crypto spot market. Each leveraged token represents a basket of perpetual contract positions. The price of the tokens reflects both the change in the nominal value of the perpetual contract positions in the basket and the chosen leverage. Unlike margin trading, you can take a leveraged position without depositing collateral, maintaining margin, or worry about liquidation risk. More so, since they are perpetual contracts, it means that they have no due date – you can hold them for as long as you want.

As a derivative, this means that leveraged tokens get their value from the underlying asset's value. And since they are leveraged, it means traders receive significantly higher profits than when they trade in the right direction in the spot market.

The leveraged tokens on KuCoin are identified using the ticker name of the underlying crypto, a number to show the leverage, and the direction of the trade – long or short. For example, BTC3L is a leverage token that is 3x bullish on BTC. That means if the price of BTC increases by 1%, the price of BTC3L increases by 3% – hence higher profits. Similarly, BTC3S is a leveraged token that's three times bearish on Bitcoin. When you buy BTC3S on KuCoin, and the price of BTC drops by 1%, you earn three times the returns.

While all this sounds exciting, you shouldn't jump into buying leveraged tokens without fully understanding them. Here are the top things you should know before you buy leveraged tokens.

A Few Things To Know About Crypto Leveraged Tokens

They Automatically Rebalance to Maintain Leverage

Unlike traditional tokens, the leveraged tokens do not have to be constant. In times of extreme volatility or price fluctuations, the leverage is automatically rebalanced. Proprietary algorithms control the rebalancing of leveraged token positions. This is designed to establish the highest possible correlation between the leveraged tokens and the underlying asset.

Rules are defined to trigger the mechanism. Typically, the rebalancing is done when the spot price fluctuates more than 15%. On the KuCoin exchange, rebalancing is done between 23:30:00 - 23:45 UTC, daily.

They Are Heavily Impacted By Leverage Volatility Decay

Leverage volatility decay occurs since the leveraged tokens cannot replicate the underlying crypto's performance over a long period. Let's use an example to explain this concept better. Suppose you buy ETH worth $1,000 in the spot market; a 10% increase in the price means that your ETH holding is worth $1,100. If the next day ETH drops by 10%, then your holding also drops by 10%; in this case, $110. So, your holding will be worth $990.

Now, if you were to invest the $1,000 in ETH3L, a 10% increase in the price of ETH means that your holding increases by 30%. Your investment will be worth $1,300. When ETH drops by 10% the next day, your holding also drops by 30%, in this case, $390. That means your investment drops to $910. When this back-and-forth fluctuation happens daily, your investment will be impacted significantly.

They Attract Additional Fees

Like the exchange-traded funds (ETFs) in the capital markets, the leveraged tokens in the crypto market attract a management fee. Although most exchanges charge trading fees for the leveraged tokens, trading them on KuCoin has the same fee schedule as trading on the spot market. However, you will be charged subscription fees of 0.1% per subscription, a 0.1% redemption fee, and management fees. The management fee is 0.045% and is charged daily at 23:45 (UTC). This fee is factored into the net asset value of the leveraged tokens.

They Are Designed to be a Short-term Investment

We mentioned earlier that leveraged tokens are perpetual contracts, meaning they don't have an expiration date – you can buy and hold them for as long as you want. However, this is usually discouraged given the impact of the volatility decay and the additional fees involved.

Remember that the crypto market is inherently volatile. Therefore, holding leveraged tokens for the long term increases the probability that you will lose money. As noted in our earlier example, you can lose more money with the leveraged tokens than when HODLing crypto.

Recommended for Advanced Traders

As you've noticed by now, leveraged tokens are high-risk products. You can be at a loss if you don't have enough knowledge about leveraged tokens before investing in them. It is not recommended for beginners. Investing in them requires a significant amount of daily market analysis and the patience to ride out any short-term volatility.

Bottom Line

Leveraged tokens provide an excellent exposure to trade in the spot crypto market with leverage without maintaining margin or collateral. Although they do not have an expiry date, they are only best as short-term investments. Knowing all the downsides before investing in a crypto asset is the most appropriate thing to do. Hence, we attempted to uncover a few crucial things for you to know before starting your investments in leveraged crypto tokens. We hope you found it informative and useful. Stay tuned and watch the KuCoin Blog for more interesting and valuable educational content. All the best!

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