Leveraged tokens and perpetual futures characterize two distinct approaches to reaching leveraged publicity. On the coronary heart of leveraged tokens’ distinctive conduct lies their rebalancing mechanism, designed to keep up leverage inside a focused vary. This contrasts with perpetual futures, the place the leverage issue fluctuates in tandem with the value actions of the underlying asset.
However past the mechanics, how do these devices fare in the actual world? Which situations favor the efficiency of 1 over the opposite? And importantly, how can one use this information to pick essentially the most acceptable instrument for his or her wants?
This text delves into these questions by analyzing numerous historic value situations and immediately evaluating the outcomes. The purpose is to light up the nuances of every choice, serving to customers to make knowledgeable selections within the evolving panorama of leveraged DeFi merchandise.
Situation one: Trending markets
Trending markets, characterised by clear and constant upward or downward value actions, present a superb instance of the distinct conduct between leveraged tokens and perpetual futures. Latest cases of such traits embrace the Solana rally, the place its worth surged from $20 to $200, and the Bitcoin rally, with its value rising from $27,000 to $73,000, each of which unfolded between October 2023 and March 2024.
In Determine 1, the efficiency comparability between the leveraged token (pink line) and the perpetual future (gray line) demonstrates a transparent benefit for the leveraged token. The underlying mechanism chargeable for this outperformance is the rebalancing course of, marked by blue vertical strains. Rebalancing robotically adjusts the place’s notional worth – basically the whole measurement of the leveraged publicity – at any time when the leverage issue hits a particular threshold. This adjustment results in elevated publicity, which in flip amplifies returns as the value continues to rise.
On this explicit instance, the perpetual future’s leverage issue had decreased from 2x to 1.06x with a notional of $18,399 by March 18th. The leveraged token’s leverage issue, alternatively, remained round 2.02x with a notional of $96,144, showcasing the potential advantages of leveraged tokens below these market situations.
Situation two: Worth actions that set off liquidations
In distinction to the conduct of leveraged tokens in state of affairs one, their efficiency throughout hostile value actions reveals a distinct benefit. In such situations, the rebalancing mechanism decreases the notional worth, resulting in decreased leveraged publicity. This considerably mitigates the chance of liquidation by lowering publicity throughout downturns.
Perpetual futures, nevertheless, don’t share this rebalancing function. They exhibit a fluctuating leverage issue till the market reaches a liquidation value.
Determine 2 illustrates such a state of affairs. The lower of the $LINK value through the first week of January 2024 led to the liquidation of the perpetual future shortly after the place was opened.
In distinction, the leveraged token, though experiencing a margin lower just like that of the perpetual future, underwent a number of rebalancings all through the downturn. These rebalancing actions successfully decreased the quantity of borrowed funds, thereby lowering leveraged publicity and stopping liquidation. This mechanism allowed the leveraged token to keep up its place all through the interval of declining costs, showcasing the chance administration capabilities inherent within the construction of leveraged tokens.
Situation three: Flat and risky value actions
The primary two situations offered insights into market situations the place leveraged tokens are likely to outperform perpetual futures. Nonetheless, rebalancing additionally introduces a possible draw back in sure market environments. Particularly, in markets characterised by flat or risky value actions, the place the necessity for frequent rebalancing – each uplevering and downlevering – may end up in what is named volatility decay. The mathematical basis underlying this course of is defined within the official Synthetix Documentation below the part “Volatility decay”.
Perpetual futures don’t face this concern and normally outperform leveraged tokens below these market situations, given they don’t get liquidated.
Determine 3 depicts a state of affairs of steady sideways motion and excessive volatility within the $LINK value. It clearly demonstrates the depreciating margin of the leveraged token over time, resulting in underperformance in comparison with the perpetual futures contract. The affect of volatility decay on the leveraged token can be additional intensified by larger leverage elements, highlighting the challenges leveraged tokens face in risky, directionless markets.
Situation 4: Steady hostile value improvement
In situations with steady hostile value motion, rebalancing can mitigate however not forestall the affect on the margin. Ought to the value of an underlying asset persistently transfer in opposition to a place, the margin of a leveraged token will inevitably decay over time. This highlights the limitation of rebalancing in safeguarding a place in opposition to extended unfavorable market traits.
Determine 4 showcases the dynamics of a brief place through the value appreciation of $ETH from February to mid-March 2024. The perpetual future confronted liquidation originally of March. In distinction, by March fifteenth, the leveraged token had nonetheless preserved 30% of its margin. Nonetheless, ought to this upward pattern proceed, the margin of the leveraged token would decay virtually fully, illustrating the gradual affect of hostile value actions on leveraged token positions.
Conclusion
Leveraged tokens and perpetual futures every shine below totally different market situations. Leveraged tokens outperform in trending markets due to their rebalancing mechanism and provide safety in opposition to liquidation in hostile actions. Nonetheless, this identical function results in volatility decay in flat or risky markets, the place perpetual futures are likely to excel, assuming they keep away from liquidation. Whereas leveraged tokens can mitigate losses in downturns, extended hostile traits can nonetheless erode their margin. Customers should take into account these dynamics, balancing the potential for amplified returns in opposition to the dangers of volatility decay and market actions, to decide on the precise instrument for his or her technique.
Disclaimer
This text is for informational functions solely and isn’t supposed as monetary or funding recommendation. All content material displays the writer’s views and shouldn’t be seen as particular funding suggestions. Traders ought to do their very own due diligence or seek the advice of an expert advisor earlier than making funding selections. The writer bears no accountability for any monetary losses ensuing from funding decisions based mostly on this text.
The mannequin used for producing the charts excludes funding charges and charges for each leveraged tokens and perpetual futures. This exclusion should not notably have an effect on the efficiency comparability.
