Diversified ETF Products: A Detailed Explanation of the Similarities and Differences Between Leveraged Tokens and Leveraged ETFs
In the cryptocurrency world, leveraged ETFs and leveraged tokens are popular products after futures. The daily trading volume of leveraged ETF products on the crypto exchanges has reached $52.81 billion. If investors are accustomed to opening positions with low leverage, they will learn that leveraged ETFs have incomparable advantages of margin trading and futures trading.
First of all, leveraged ETF positions have higher capital utilization. This is mainly because there is no need to pay margin when opening a leveraged ETF position. Opening and closing a position is like buying and selling on Spot, so there is no need to occupy part of the position as the margin to raise or lower the liquidation price.
Secondly, the leveraged ETF rebalancing mechanism allows the benefits of compound interest investment. After rebalancing, the profit of the position is automatically added to the newly opened position, which is suitable for trading in the bull market.
Among mainstream exchanges, Binance, MEXC and FTX have three years of mature experience related to the product, and their 24-hour user trading volume occupies the top three rankings.
However, many people are easily confused about leveraged ETF and leveraged tokens. This article will focus on introducing the two to understand the characteristics of these products.
1. Similarities and differences between leveraged ETFs and leveraged tokens
Leveraged ETF is a type of perpetual leveraged product that amplifies the price changes of Spot trading, which aims to provide leveraged returns to benchmarks like the perpetual futures.
The name of the leveraged ETF is represented by “cryptocurrency + leverage + long/short direction”. For example, BTC3L/3S means a 3x long/short for Bitcoin. If the BTC price goes up/down by 1% on a particular day, BTC3L will go up/down by 3% and BTC3S will go down/up by 3%.
Leveraged ETF of cryptocurrency originates from the principle of leveraged ETF in the traditional financial market. It is an exchange-traded fund issued off-chain, while leveraged tokens, on the other hand, are similar to leveraged ETFs in that they are also traded products that achieve a certain multiple (e.g. 3x) of the targeted daily asset return given the underlying asset (e.g. BTC).
However, leveraged tokens are issued on the chain. For every leveraged token purchased by a user, the corresponding token is issued on the Ethereum blockchain, on the contrary, it is burned and destroyed. This is the essential difference between leveraged tokens and leveraged ETFs. Therefore, leveraged tokens can be understood as “leveraged ETFs” issued on a blockchain.
Therefore, when the trading activity on the Ethereum blockchain is high, the trading fee of leveraged tokens becomes high, and trading becomes congested as well. This does not happen for leveraged ETFs.
In addition, the issue price of leveraged ETFs is $1, while the issue price of leveraged tokens is different. Data on the Ethereum blockchain shows that the price of the leveraged 3x long BTC token is $3460.56 on January 16.
2. The advantages of leveraged ETF products
Leveraged ETFs do not require margin, there is no liquidation price, and the capital utilization is high; it has a compound interest effect, and risks are easy to control.
No margin required, no liquidation price, high capital utilization: Take BTC3L as an example, users open positions in leveraged ETFs as if they were trading Spot, without having to take up part of their positions as a margin to raise or lower the liquidation price — the capital utilization is high and no liquidation rules.
Compound interest effect: Due to the rebalancing mechanism of leveraged ETFs, during continuous up/down market, the daily profit portion is automatically transferred to the position for reinvestment to achieve compound interest, so the profit will be higher than leveraged or futures products of the same leverage.
Risk control: The risk control and compound interest effect of leveraged ETFs originate from a unique rebalancing mechanism. Rebalancing is divided into periodic rebalancing and non-periodic rebalancing.
Periodic rebalancing is essentially what the platform does to maintain the 3, 4, or 5 times leverage of an ETF. In addition, the platform also needs to carry out risk hedging on other derivatives platforms to avoid the risks caused by the sharp rise and fall of prices, and maintaining the leverage ratio and hedging, both incur a certain fee rate erosion.
MEXC’s leveraged ETF products will be rebalanced regularly at 0:00 Singapore time every day, and the existing position accounts will be charged at a fee rate. For example, the current BTC3L fee rate is 0.2%.
Non-periodic rebalancing refers to the scenarios when the target spot price rises or falls by more than a certain range, 3L or 3S position holders need to pay management fees according to the fee rate.
For example, when the BTC spot price is 50,000 USDT, and BTC3L and BTC3S are listed. So, the anchored BTC spot price for the non-periodic rebalancing of both BTC3L and BTC3S will be 50,000 USDT.
The periodic rebalancing is triggered when the BTC spot price rises or falls by more than 15%, meaning that the BTC spot price reaches 57,500 USDT or 42,500 USDT.
3. Diversity of ETF products
ETF products of the cryptocurrencies are not only popular in the crypto world, but also sought after by traditional financial institutions and capital funds, and are suitable as the investment of large capital funds.
In fact, in recent years, Bitcoin promoters in the United States have continuously applied to regulators for the launch of Bitcoin ETFs. As of October 22, 2021, the U.S. SEC has approved the first Bitcoin futures ETF BITO (launched by ProShares). Eric Balchunas, a senior ETF analyst of Bloomberg, had counted that the trading volume of the product reached $280 million within 20 minutes of its listing. Subsequent inflows reached $1.2 billion over the next four days.
Although the ProShares product was the first Bitcoin ETF in the U.S., several Bitcoin ETFs in Canada have already been traded on the Toronto Stock Exchange, including the Purpose Bitcoin ETF and the 3iQ Bitcoin ETF.
Concurrent with the ETF BITO’s launch, Grayscale also applied to the SEC to convert the Grayscale Bitcoin Trust (GBTC) into a Bitcoin spot ETF.
The push for cryptocurrency ETFs by traditional institutions has helped increase market exposure and allow more inflows of traditional funds, which is definitely a good thing. However, it mainly targets ETF products of BTC and ETH, particularly ETF futures.
Meanwhile, the leveraged ETF launched by the crypto exchanges has incomparable advantages when compared to the above ETF products.
Taking MEXC’s leveraged ETF as an example, its tradable products have reached more than 360 trading pairs consisting of more than 180 cryptocurrencies. MEXC is currently the trading platform with the highest number of leveraged ETF trading categories in the network. Its ETF products include not only Bitcoin leveraged ETFs and Ethereum leveraged ETFs (such as BTC 3L/3S, ETH3L/3S), but also cover many current leveraged ETF trading pairs of mainstream tokens such as BNB3L/3S, DOT3L/3S, LTC3L/3S, etc., as well as leveraged ETF trading pairs of popular tokens such as ATOM3L/3S, FTM3L/3S, LUNA3L/3S, SOL3L/3S, etc.
Given that cryptocurrencies follow the BTC market trend, there is a huge gap between the price changes, and they usually resonate with the popular sectors. This gives investors more options while considering expected returns.
For example, when BTC3L’s 24-hour decline of 3.67% on January 16, trading SOL3L could allow one to achieve a gain of 19.78%.