Leveraged tokens and perpetual futures signify two distinct approaches to attaining leveraged publicity. On the coronary heart of leveraged tokens’ distinctive conduct lies their rebalancing mechanism, designed to take care of leverage inside a focused vary. This contrasts with perpetual futures, the place the leverage issue fluctuates in tandem with the worth 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 data to pick probably the most applicable instrument for his or her wants?
This text delves into these questions by analyzing varied historic value situations and instantly evaluating the outcomes. The objective is to light up the nuances of every possibility, serving to customers to make knowledgeable selections within the evolving panorama of leveraged DeFi merchandise.
State of affairs one: Trending markets
Trending markets, characterised by clear and constant upward or downward value actions, present a wonderful instance of the distinct conduct between leveraged tokens and perpetual futures. Latest cases of such tendencies embody 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 answerable for this outperformance is the rebalancing course of, marked by blue vertical traces. Rebalancing routinely adjusts the place’s notional worth – basically the whole dimension of the leveraged publicity – each time the leverage issue hits a particular threshold. This adjustment results in elevated publicity, which in flip amplifies returns as the worth 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, however, remained round 2.02x with a notional of $96,144, showcasing the potential advantages of leveraged tokens underneath these market situations.
State of affairs two: Value actions that set off liquidations
In distinction to the conduct of leveraged tokens in situation one, their efficiency throughout adversarial value actions reveals a distinct benefit. In such situations, the rebalancing mechanism decreases the notional worth, resulting in lowered leveraged publicity. This considerably mitigates the chance of liquidation by reducing publicity throughout downturns.
Perpetual futures, nonetheless, don’t share this rebalancing function. They exhibit a fluctuating leverage issue till the market reaches a liquidation value.
Determine 2 illustrates such a situation. The lower of the $LINK value in the course of 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 much like that of the perpetual future, underwent a number of rebalancings all through the downturn. These rebalancing actions successfully lowered the quantity of borrowed funds, thereby reducing leveraged publicity and stopping liquidation. This mechanism allowed the leveraged token to take care of its place all through the interval of declining costs, showcasing the chance administration capabilities inherent within the construction of leveraged tokens.
State of affairs 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 – can lead to what is named volatility decay. The mathematical basis underlying this course of is defined within the official Synthetix Documentation underneath the part “Volatility decay”.
Perpetual futures don’t face this challenge and often outperform leveraged tokens underneath these market situations, given they don’t get liquidated.
Determine 3 depicts a situation 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 impression of volatility decay on the leveraged token can be additional intensified by greater leverage components, highlighting the challenges leveraged tokens face in risky, directionless markets.
State of affairs 4: Steady adversarial value growth
In situations with steady adversarial value motion, rebalancing can mitigate however not stop the impression on the margin. Ought to the worth of an underlying asset persistently transfer towards a place, the margin of a leveraged token will inevitably decay over time. This highlights the limitation of rebalancing in safeguarding a place towards extended unfavorable market tendencies.
Determine 4 showcases the dynamics of a brief place in the course of 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 nearly fully, illustrating the gradual impression of adversarial value actions on leveraged token positions.
Conclusion
Leveraged tokens and perpetual futures every shine underneath totally different market situations. Leveraged tokens outperform in trending markets due to their rebalancing mechanism and provide safety towards liquidation in adversarial actions. Nonetheless, this similar 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 adversarial tendencies can nonetheless erode their margin. Customers should take into account these dynamics, balancing the potential for amplified returns towards the dangers of volatility decay and market actions, to decide on the proper instrument for his or her technique.
Disclaimer
This text is for informational functions solely and isn’t meant 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 knowledgeable advisor earlier than making funding selections. The writer bears no accountability for any monetary losses ensuing from funding decisions primarily based on this text.
The mannequin used for producing the charts excludes funding charges and costs for each leveraged tokens and perpetual futures. This exclusion should not notably have an effect on the efficiency comparability.
