What are Leveraged Tokens?
Leverage tokens offer a leveraged position in trading, letting you increase your earnings without any of the hassle of maintaining a position like in margin trading. We’ve got everything you need to know about leveraged tokens, including how leveraged tokens work, the benefits, and the risks.
Leveraged tokens are specialized crypto tokens that amplify the price movements of an underlying asset (e.g., 2× long, 3× short)
Main benefits include easy access to leverage, no risk of margin calls, and automatic rebalancing that adjusts exposure for you
But, they carry significant risks as frequent rebalancing can cause value decay in volatile markets, and long-term returns may underperform the underlying asset
When you buy, sell, or trade these tokens, any gains or losses are typically treated as capital gains for tax purposes
What are leveraged tokens?
Put simply, a leveraged token gives you a leveraged position when trading. A leveraged position multiplies your profits - and your losses. They’re essentially a tokenized version of a more traditional derivatives contract like futures.
For example, ETHBULL is a 3x long ETH leveraged token. So it triples the profits of ETH gains, as well as tripling the losses. So if the price of ETH increased by 1%, ETHBULL increases by 3%. Similarly, if the price of ETH dropped by 1%, the price of ETHBULL drops by 3%.
As you can see from the example above, leveraged tokens are high risk, and you shouldn’t invest in them without fully understanding the potential losses. So let’s look at how they work..
How do leveraged tokens work?
You can get long (bull) or short (bear) leveraged tokens. Long leveraged tokens bet on the price of the underlying crypto asset to go up, while short leveraged tokens bet on the price of the underlying crypto asset to go down.
There are also fixed leverage tokens and variable leverage tokens. Fixed leverage tokens have a fixed position. As in, the amount of leverage you have won’t change - it’ll always be 0.5X, 1X, 2X, 3X, and so on. So you’ll only ever gain or lose a certain amount.
Meanwhile, variable leverage tokens don’t maintain a constant leverage. Instead, they aim for a target range of variable leverage, between 0.25X and 4X normally. This means you can gain much more and lose much more.
To maintain the target leverage with the underlying asset, leverage tokens go through what’s known as rebalancing, and it happens automatically. Rebalancing works slightly differently on every crypto exchange offering leveraged tokens, so we’ll give a general overview.
Normally, rebalancing happens at a set point in the day, like 2 AM. However, if it’s been a volatile market and the price has dropped or risen by more than 10%, many leveraged tokens automatically rebalance at this point. Each platform will have a different rebalancing protocol.
When a leveraged token rebalances, if the price has gone up, the profits are reinvested into the underlying asset. If the price has gone down, you’ll sell some of your position (tokens) to cover the losses.
Read next: How to short crypto
Where can I buy and sell leveraged tokens?
There are a few large crypto exchanges offering leveraged tokens, including:
You can buy and sell leveraged tokens on the spot market, like you would any other token or coin. Depending on the platform, you can also redeem them for the value they represent.
There are also an increasing number of decentralized exchanges offering leveraged tokens.
Can leveraged tokens get liquidated?
One of the big benefits of leveraged tokens is that they cannot get liquidated in the same manner as traditional leveraged positions can, because you do not maintain a margin in the same way. Instead, you'd sell some of your tokens automatically to maintain your position.
What are the benefits of leveraged tokens?
The obvious benefit of leveraged tokens is that if you manage to bet which way the market will go, you’ll have higher gains than you would when you trade a non-leveraged coin.
As well as this, leveraged tokens have some key benefits over other leveraged products. For starters, unlike with margin trading, you don’t need to maintain a margin. So you don’t need to have a given amount of collateral to open a position; you can just buy the leveraged token, and you automatically have that position.
This is because risk is automatically managed with leveraged tokens. You don’t need to add more collateral if the price goes down or close if the price goes up, thanks to the rebalancing function. This means the risk of liquidation is much lower with leveraged tokens.
Because of the lowered risk, most exchanges charge a lower management fee to keep your position open than for traditional leveraged products.
They also increase your liquidity. You might only have a certain amount you can currently invest. So you can increase your profits without investing more by leveraging your position with lower risk than many other leveraged products.
What are the risks of leveraged tokens?
The obvious risk is loss. If you bet the wrong way, you’re going to lose a lot - much more than you would have done if you hadn’t taken a leveraged position. Particularly for variable leveraged tokens where you have no fixed position, the losses can be huge.
While the risk of liquidation is much lower thanks to rebalancing, it doesn’t mean that it couldn’t happen if the market conditions were rough enough.
One of the biggest risks around leveraged tokens is what’s known as volatility decay. This is the negative impact of a volatile market on an investment. For example, let’s say you bought $100 of ETH and the price increased by 20% in a day, giving you $120. The day after, it decreases by 20%, so you lose $24. You’re left with $96. Easy enough, but now imagine you bought a leveraged position instead.
You buy $100 of ETHBULL, a 3X long leveraged token. The first day, your price goes up by 20% to $160. The next day, it drops by 20%, losing you $96 and leaving you with $64. You’ve lost more of your assets than you would have normally because of your leveraged position. This is an extreme example, but it shows that even minor losses would eat away at the value of your asset much faster than with regular crypto trading.
There are also additional fees involved in leveraged tokens compared to regular cryptocurrencies. They have a management fee (normally of between 0.01% - 0.03%), as well as a redemption fee if you choose to claim the value of the underlying asset instead of selling your leveraged token.
Leveraged tokens tax
Leveraged tokens are taxed like any other crypto asset. While tax authorities haven’t issued specific guidance yet, existing crypto tax rules still apply to common leveraged token transactions:
Buying a leveraged token: If you purchase a leveraged token using fiat currency (like USD or GBP), it’s not a taxable event; you’re simply buying an asset with cash. However, if you buy a leveraged token using another cryptocurrency, this is taxable because crypto-to-crypto swaps trigger Capital Gains Tax. You’ll owe tax on any profit made from the crypto you used to make the purchase.
Selling a leveraged token: When you sell a leveraged token, whether for fiat or another cryptocurrency, you’ll pay Capital Gains Tax on any profit made since you acquired it. If the token’s value has decreased, you can record a capital loss instead, which may be used to offset other gains and reduce your overall tax bill.
Redeeming a leveraged token: Redeeming a leveraged token (exchanging it back for the underlying asset or equivalent value) is treated the same as a sale for tax purposes. You’ll need to calculate the difference between the token’s value when you bought it and its value when you redeemed it, and pay Capital Gains Tax on any increase.
Rebalancing a leveraged token: Tax offices haven’t released specific rules on rebalancing yet, but it’s generally viewed as a mix of buying and selling events within the token. When prices rise, you’re effectively buying more crypto as exposure increases; when prices fall, you’re selling some. Both could have tax implications depending on how your jurisdiction treats these internal adjustments.
How Koinly crypto tax calculator can help
Koinly makes crypto tax reporting easy, no more spreadsheets or manual calculations. It connects with all major exchanges and wallets, including platforms offering leveraged tokens like Binance, KuCoin, and Pionex. Simply sync your accounts via API or upload a CSV file, and Koinly automatically calculates your taxable transactions, capital gains, losses, and income.
