How Do Leveraged Tokens Work?

Leveraged tokens are financial instruments that allow investors to gain magnified exposure to the underlying assets, such as cryptocurrencies, commodities, or equities, without the need to manage a margin account. These tokens use financial derivatives, such as futures and swaps, to amplify the returns of the underlying asset by a specified multiple, such as 2x or 3x. They can provide substantial gains in a short period if the market moves favorably, but they also come with increased risk of significant losses if the market moves against the investor. Leveraged tokens are traded on various exchanges and can be used for both long and short positions. The design of these tokens typically involves the rebalancing of the derivatives used to maintain the desired leverage, which can lead to deviations from the expected performance over time. For example, a 3x long Bitcoin token aims to return three times the daily movement of Bitcoin's price, while a 3x short token aims to return three times the inverse of Bitcoin's price movement. Due to their complexity and risk, leveraged tokens are generally recommended for experienced investors who can closely monitor their positions and understand the potential for volatility and decay.