Leveraged Token Walkthrough

Disclaimers

1. None of this is investment advice.
2. Much of the below analysis ignores any difference between futures and spot prices, and ignores the effects of fees.  It also ignores slippage incurred while rebalancing, and generally assumes that all transactions happened at theoretical prices rather.
3. While your account's holding of a leveraged token cannot be liquidated, the leveraged token itself theoretically could be.  Leveraged tokens greatly reduce the risk of liquidation but cannot make it fully impossible; if markets instantaneously gap down 50%, there is nothing that can stop the +3x leveraged position held by the leveraged token from getting liquidated. In addition, while leveraged tokens attempt to avoid getting liquidated, this does not prevent them from being able to suffer heavy losses.
4. Leveraged tokens can have unintuitive edge cases. The below is a summary of their common behavior.
5. While this does generally describe how Leveraged Tokens work, it contains approximations and should not be taken as precise.
6. Users should trade Leveraged Tokens at their own risk.

What Are Leveraged Tokens?
Leveraged tokens are ERC20 tokens that have leveraged exposure to crypto.  You can find the list of leveraged tokens here.
For example, take ETHBULL, a 3x long ETH token.  For every 1% ETH goes up in a day, ETHBULL goes up 3%; for every 1% ETH goes down, ETHBULL goes down 3%.
There are currently three leveraged tokens for every future : BULL (+3x), BEAR (-3x), and HEDGE (-1x).  Generally, if ETH goes up 1% during a day, then ETHBULL goes up 3%, ETHBEAR goes down 3% and ETHHEDGE goes down 1%.  If ETH goes down 1% during a day, then ETHBULL goes down 3%, ETHBEAR goes up 3% and ETHHEDGE goes up 1%.

Some futures may have leveraged tokens with other margin ratios.

 

 

Note: Leveraged Tokens are high risk products.  Only trade them if you understand how they work.  They might gain or lose large amounts of their value in a day.

How Do Leveraged Tokens Work?
Each leveraged token gets its price action by trading FTX perpetual futures.  For instance, say that you want to create $10,000 of ETHBULL.  To do so you send in $10,000, and the ETHBULL account on FTX buys $30,000 worth of ETH perpetual futures. Thus, ETHBULL is now 3x long ETH.

You can also redeem leveraged tokens for their net asset value.  To do that, you can send your $10,000 of ETHBULL back to FTX, and redeem it.  This will destroy the token; cause the ETHBULL account to sell back the $30,000 worth of futures; and credit your account with $10,000.

This creation and redemption mechanism is what ultimately enforces that the leveraged tokens are worth what they're supposed to be.

Why Use Leveraged Tokens?
There are three reasons to use leveraged tokens.

Managing Risk
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 leveraged positions with that.

Conversely, leveraged tokens will automatically reduce risk if they lose money.  If you put on a 3x long ETH position and over the course of a month ETH falls 33%, your position will be liquidated and you will have nothing left.  But if you instead buy ETHBULL, the leveraged token will automatically sell off some of its ETH as markets go down--likely avoiding liquidation so that it still has assets left even after a 33% down move.

Managing Margin 
You can buy leveraged tokens just like normal ERC20 tokens on a spot market.  No need to manage collateral, margin, liquidation prices, or anything like that; you just spend $10,000 on ETHBULL and have a 3x leveraged long coin.

ERC20 Tokens
Leveraged tokens are ERC20 tokens.  That means that--unlike margin positions--you can withdraw them from your account!  You go to your wallet and send leveraged tokens to any ETH wallet.  This means you can custody your own leveraged tokens; it also means you can send them to other platforms that list the leveraged tokens, like Gopax or Binance.

How Do You Buy/Sell Leveraged Tokens?
There are multiple ways to do so.

Spot markets (Recommended)
The easiest way to buy a leveraged token is on its spot market.  For instance you can go to the ETHBULL/USD spot market and buy or sell back ETHBULL.  You can find a leveraged token's spot market by going to the tokens page and clicking on the name; or by clicking on the underlying future on the top bar and then on the name of the market.

Note that FTX isn't the only exchange that lists leveraged tokens!  You can trade FTX's HEDGE tokens on Gopax as well.  Because they're ERC20 tokens, the 'BTCHG' on Gopax is the same token as 'HEDGE' on FTX; you can send them back and forth using your wallet.

Convert
You can also buy or sell leveraged tokens directly from your wallet page using the 'CONVERT' function.  If you find a token and click 'CONVERT' on the right hand side of the screen, you'll see a dialog box in which you can easily turn any of your coins on FTX into the leveraged token.

Creation/Redemption
Finally, you can create or redeem leveraged tokens.  This is not recommended unless you have read through all of the documentation on leveraged tokens.  Creating or redeeming leveraged tokens will have market impact and you won't know what price you ultimately get until after you've created or redeemed.  We recommend using the spot markets instead.

You can create or redeem a leveraged token by going to the tokens page and clicking 'more info'.  If you create $10,000 of ETHBULL, this will send a market order to buy $30,000 of ETH-PERP, calculate the price paid, and then charge you that amount of money; it'll then credit your account with the corresponding amount of ETHBULL.

How Do Leveraged Tokens Rebalance?
Every day at 00:02:00 UTC the leveraged tokens 'rebalance'.  That means that each leveraged token trades on FTX in order to once again reach its target leverage.

For instance, say that the current holdings of ETHBULL are -$20,000 and + 150 ETH per token, and ETH is trading at $210.  ETHBULL has a net asset value of (-$20,000 + 150*$210) = $11,500 per token, and an ETH exposure of 150*$210 = $31,500 per token.  Thus its leverage is 2.74x, and so it needs to buy more ETH in order to return to 3x leverage, and will do so at 00:02:00 UTC.

Thus, every day each leverage token reinvests profits if it made money.  If it lost money, it sells off some of its position, reducing its leverage back to 3x in order to avoid liquidation risk.
In addition, any token will rebalance if an intraday move causes its leverage to be 33% higher than its target.  So if markets move down enough that BULL token is 4x leveraged it will rebalance.  This corresponds to market moves of roughly 11.15% for BULL tokens, 6.7% for BEAR tokens, and 30% for HEDGE tokens.
This means that leveraged tokens can give up to 3x leverage without much risk of liquidation.  It would require a 33% market move to liquidate a 3x leveraged token, but the token will generally rebalance within a 6-12% market move, reducing its risk and returning to 3x leveraged.

Specifically, the way rebalances happen is:

1. FTX periodically monitors for LT leverages.  If any LT leverage goes above 4x in magnitude, it triggers a rebalance for that LT.
2. When a rebalance is triggered, FTX calculates the number of units of the underlying the LT needs to buy/sell to return to 3x leverage, marked to prices at that time.
3. The formula for this is:
4. Desired position (DP): [Target Leverage] * NAV / [underlying mark price]
   B. Current Position (CP): current holdings per token of the underlying
   C. Rebalance size: (DP - CP) * [LT tokens outstanding]
5. FTX then sends orders in the associated FTX perpetual futures orderbook to rebalance (e.g. ETH-PERP for ETHBULL/ETHBEAR).  It sends a maximum of $4m of orders per 10 seconds until it has sent the desired total size.  These are all normal, public IOCs that trade against the prevailing bids/offers in the orderbook at the time. 
6. Note that this ignores difference between the underlying price when a rebalance is triggered and when it happens; ignores fees; and may have rounding errors.

What Are Leveraged Tokens' Performance?

Daily Move
Each day, leveraged tokens will have their target performance; so for example, each day (from 00:02:00 UTC to 00:02:00 UTC the next day) ETHBULL will move 3x as much as ETH.

Multiple Days
However, over longer time periods leveraged tokens will perform differently than a static 3x position.
For instance, say that ETH starts at $200, then goes to $210 during day 1, and then to $220 during day 2.  ETH increased 10% (220/200 - 1), so a 3x leveraged ETH position would have increased 30%.  But ETHBULL instead increased 15% and then 14.3%.  On day 1 ETHBULL increased the same 15%.  Then it rebalanced, buying more ETH; and on day 2 it increased 14.3% of its new, higher price, whereas a 3x long position would have just increased another 15% of the original $200 ETH price.  So during this 2-day stretch, the 3x position is up 15% + 15% = 30%, but ETHBULL is up 15% from the original price, plus 14.3% of the new price--so it's actually up 31.4%.

This difference comes because the compounded increase on a new price is different from moving up 30% from the original price.  If you move up twice, the second 14.3% move is on a new, higher price--and so it's actually a 16.4% increase on the original, lower price.  In order words, your gains compound with leveraged tokens.

Rebalance Times
Leveraged tokens' performance will be 3x the underlying performance if you're measuring since the last rebalance time.  In general leveraged tokens rebalance every day at 00:02:00 UTC.  This means that the trailing 24h moves might not be exactly 3x the underlying performance, rather the moves since midnight UTC will be.

In addition, leveraged tokens that are over leveraged rebalance whenever their leverage reaches 33% higher than its target.  This happens, roughly, when the underlying asset moves roughly 11.15% for BULL tokens, 6.7% for BEAR tokens, and 30% for HEDGE tokens.  So in fact the leverage token performance will be 3x the underlying asset since the asset last moved 6-12% that day if there was a large move and the token lost to it, and since midnight UTC if there wasn't.

The Formula
If the movement of the underlying asset on days 1, 2, and 3 is M1, M2, and M3, then the formula for the price increase of the 3x leveraged token is:
New Price = Old Price * (1 + 3*M1) * (1 + 3*M2) * (1 + 3*M3)
Price movement in % = New Price / Old Price - 1 = (1 + 3*M1) * (1 + 3*M2) * (1 + 3*M3) - 1

When Do Leveraged Tokens Do Well?
Obviously the BULL tokens do well when prices go up, and the BEAR tokens do well when prices go down.  But how do they compare to normal margin positions?  When does BULL do better than a +3x leveraged position, and when does it do worse?

Reinvesting Profits
Leveraged tokens reinvest their profits.  That means that, if they have positive PnL, they'll increase their position size.  So, comparing ETHBULL to a +3x ETH position: if ETH goes up one day and then up again the next, ETHBULL will do better than +3x ETH, because it reinvested the profits from the first day back into ETH.  However, if ETH goes up and then falls back down, ETHBULL will do worse, because it increased its exposure.

Reducing Risk
Leveraged tokens reduce their risk if they have negative PnL to avoid liquidations.  So, if they have negative PnL, they'll reduce their position size.  Comparing ETHBULL to a +3x ETH position again: if ETH goes down one day and then down again the next, ETHBULL will do better than +3x ETH: after the first loss ETHBULL sold off some of its ETH to return to 3x leverage, while the +3x position effective became even more leveraged.  However, if ETH goes down and then back up, ETHBULL will do worse: it reduced some of its ETH exposure after the first loss, and so took less advantage of the recovery.

Example:
As an example, comparing ETHBULL to 3x long ETH:

ETH daily prices	ETH	3x ETH	ETHBULL
200, 210, 220	10%	30%	31.4%
200, 210, 200	0%	0%	-1.4%
200, 190, 180	-10%	-30%	-28.4%

Summary
In the above cases, leveraged tokens do well--or at least better than a margin position that starts out the same size--when markets have momentum.  However they do worse than a margin position when markets mean-revert.

A common misconception is that leveraged tokens have exposure to volatility, or gamma.  Leveraged tokens do well if markets move up a lot and then up a lot more, and poorly if markets move up a lot and then back down a lot, both of which are high volatility.  The real exposure that they have is primarily to price direction, and secondarily to momentum.

What do Leveraged Tokens hold?
Leveraged Tokens hold perpetual futures on FTX.  That means that they will get their exposure to the underlying assets through the perpetual futures.  That also means that they will be subject to the price movements, premiums, funding rates, etc. of the perpetual futures.