What are Leveraged ETF Tokens?

Foreword

In addition to the popular spot trading, there are many other derivatives available for investors to choose from in financial markets, or crypto space. One of the most widely traded crypto derivatives is perpetual contracts, which are similar to a traditional futures contract but have no expiration. The underlying asset tracks the price in the spot market, allowing users to make profits or hedge risks by going long or short, and to improve capital utilization through leverages.

However, contract trading is more opted by sophisticated traders and institutions due to its high barrier and the liquidation risk when the price moves aren’t predicted. To allow users to participate, Gate.io provides leveraged ETF token products, which can be traded the same way as spot products and generate leveraged gains. Positions will never be liquidated even if the market is mispredicted, which significantly lowers the barrier for ordinary users.

What are leveraged ETF tokens?

ETFs, short for exchange-traded funds, refer to investment funds traded by brokers or on exchanges. An ETF may be composed of spot products, bonds, and financial derivatives, and could replicate the yield rate of underlying assets or indexes. Currently, the leveraged ETF tokens on Gate.io are pegged to a single designated cryptocurrency and track its price at a ratio of approximately 3:1 (3X products) and 5:1 (5X products).

Unlike those common leveraged products, the trading of leveraged ETF tokens on Gate.io does not require collateral. Users can make profits simply by buying and selling their chosen products, just as they do in spot trading. Leveraged ETF tokens are essentially perpetual contracts, whose positions are managed by Gate.io and will be adjusted dynamically according to the real-time market price to maintain the leverage ratio at a specific level and avoid liquidation. This allows users to easily build leveraged portfolios of their own without considering too many details.

Risk hedging is an essential part of the perpetual contracts trading of ETFs, which incur a high cost of capital utilization and management. Therefore, Gate.io charges 0.1% of the daily net value of the products as the management fee to cover frictional expenses, such as commission fees, funding fees, price slippages, etc.

Traditional ETFs vs crypto ETFs

The first ETF in the world, called TIPS 35, is an index ETF launched by Toronto Stock Exchange in 1990. It is composed of stock shares of 35 companies in different proportions, allowing anyone to invest in them without the need to hold shares of these companies directly.

In 1993, the American Stock Exchange launched SPDE, a commodity ETF that tracks S&P 500. After that, ETFs began to attract investors and became increasingly popular. Following that, American Stock Exchange launched a variety of ETFs that track specific indexes. For example, QQQ tracks NASDAQ100.

ETF today is playing a significant role in traditional finance. They are revolutionizing the market and allowing for more diversified investment portfolios. With the rise of the cryptocurrency industry, different types of cryptocurrency ETFs have emerged, allowing investors to obtain revenues equal to that of the underlying assets by simply buying and selling ETFs. Notably, they do not need to actually hold the cryptocurrency or the contract.

The leveraged ETF tokens provided by Gate.io are similar to ETFs in traditional finance. A difference is that the leveraged ETF tokens only track a single cryptocurrency (such as Bitcoin and Ether), instead of a basket of different assets. Leveraged ETF tokens are essentially perpetual contract products that use leverages, intending to obtain higher returns from the specified token.

How leveraged tokens multiply gains and losses?

Leveraged ETF tokens are actually leveraged perpetual contracts. The value of the contract position will change as the market price fluctuates, which is shown in the price (net value) of the leveraged ETF tokens.

For example, assuming that the market price of BTC now is $20,000 and would rise to $25,000 a month later. To make a spot trade of BTC, you could simply buy one at $20,000 and sell it at $25,000, thereby making a profit of $5,000 from the price spread. The price spiked by 25% during the month, which is exactly the same as the 25% of return that you could get from trading.

However, if you go long with a 3X leveraged perpetual contract, you can hold a long Bitcoin perpetual contract position that is worth $60,000 with a principal of $20,000 (without considering the commission rate and maintenance margin ratio). If the price of BTC rises to $25,000, the value of your long position will be $75,000. If you choose to close the position at this point, you can get a profit of $15,000.

Though the price of BTC has only increased by $5,000, or 25%, the 3X leverage will make the profits magnify by 3 times. That is why your profits increase from $5,000 to $15,000, with a yield return of 75%.

As can be seen from this example, the triple leverage of a perpetual contract means that users can hold a contract position of triple value with the same principal. The position value of a perpetual contract = position size * price of the underlying asset.

Since leveraged ETF tokens are actually leveraged perpetual contracts, the value of the leveraged tokens equals that of the perpetual contract position.

1. Value of leveraged tokens = the amount of leveraged tokens * the price of leveraged tokens = the position value of the perpetual contract.

The amount of leveraged tokens a user holds will not increase or decrease randomly. When the position value of a perpetual contract increases, the price (net value) of the leveraged token will rise correspondingly. This demonstrates that the leverage ratio is shown in the price (net value) of the leveraged token.

Explaining the name of leveraged ETF token products

On the leveraged tokens page on Gate.io, you will see all available leveraged ETF token products. Before making an actual investment, it is necessary to understand what each part of a product’s name stands for. Generally, the name of an ETF leveraged token consists of three parts, as shown in the picture below:

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Underlying asset

The first few letters before the number indicate the underlying asset. In the above picture, BTC5L means that the underlying asset is BTC, referring to a leveraged BTC product.

Leverage ratio

The numeral in the middle of the product name indicates the leverage ratio. There are two different numerals on Gate.io, 3 and 5, representing 3 times leverage and 5 times leverage respectively. For example, BTC5L refers to a 5 times leveraged token.

Direction (long or short)

The last few letters of the product name indicate the direction. It is either L or S on Gate.io, representing being long (bullish) and short (bearish) respectively.

Some other leveraged ETF tokens on Gate.io end in BULL and BEAR, which means they are issued by other platforms but are tradable on Gate.io. BULL refers to going long and BEAR refers to going short.

Net value vs transaction price

As a fund product, each unit of the leveraged tokens is actually a share of the fund, which is generally represented by net value. Net value can be regarded as the price of leveraged tokens in the primary market. Net value multiplied by the total amount of leveraged tokens is the position value of the perpetual contract.

The transaction price is the fair price of leveraged ETF tokens in the secondary market, and also the price that users actually deal with when buying and selling leveraged tokens. The net value of leveraged ETF tokens will not be affected by users’ buying and selling behaviors, but by the performance of contracts. However, the transaction price of leveraged ETF tokens will be affected by buying and selling behaviors.

Typically, the net value is close to the transaction price of the leveraged tokens in the secondary market. However, due to market fluctuations, the transaction price can deviate from the fair price (that is, the net value of the fund), resulting in a price premium or discount.

Position adjustment mechanism

The position size of the leveraged ETF tokens is adjusted in a timely manner, in case the leverage ratio increases or decreases when the price fluctuates significantly.

Assuming that the market price of BTC is $20,000, a BTC3L product uses $20,000 to go long on a perpetual contract worth $60,000. Then the leverage ratio is (position value)/(principal) = 3.

Soon after, BTC’s price rises to $25,000 and the contract value increases to $75,000. At this time, the collateral includes the unrealized profit of $15,000 in addition to the initial investment of $20,000. The leverage ratio now is 75,000/ 35,000 = 2.143.

We can conclude that when the position has a profit, the real-time leverage ratio will decrease. Conversely, when losses occur, the real-time leverage ratio will increase. Therefore, in order to maintain the leverage ratio at a specified level, it is necessary to increase the position when the leverage ratio is low and reduce the position when it gets too high.

Gate.io introduces two rebalancing mechanisms for leveraged ETF tokens: regular rebalancing and irregular rebalancing. For 3X leveraged ETFs, when the real-time leverage ratio is greater than 3 or less than 1.8, regular rebalancing will be triggered at 0:00 (UTC+8) every day to adjust the leverage back to 2.3. For 5X ETFs, when the real-time leverage ratio is greater than 7 or less than 3.5, regular rebalancing will be triggered at 0:00 (UTC+8) every day to adjust the leverage back to 5.

Irregular rebalancing is executed, only when the leverage ratio rises sharply due to severe market fluctuations, to avoid liquidation. It will be triggered when the leverage ratio of 3X ETFs is greater than 3 or 5X ETFs greater than 7.

Management fee

Gate.io charges an ETF management fee of 0.1% at 0:00 (UTC+8) every day, which is directly collected from the net asset value. The number of leveraged ETF tokens a user holds will not decrease, but the token price may drop due to the decrease in net value. Hence, it is not advised to hold leveraged ETF tokens for a long period because the management fee will lower your income.

Leveraged ETF tokens vs contract trading

In contract trading, collateral is required to open a position and is likely to be liquidated. However, the leveraged ETF tokens provided by Gate.io do not require collateral and are free from liquidation.

In addition, the leverage ratio in contract trading will change with market fluctuations, which requires manual adjustment to maintain it at a fixed level. By contrast, the contract positions of leveraged ETF tokens are managed by Gate.io, which is responsible for increasing or decreasing the positions automatically based on the real-time market situation.

In contract trading, funding fees are required every 8 hours, while the ETF products on Gate.io charge management fees on a daily basis.

Leveraged ETF tokens vs leveraged trading (margin trading)

Leveraged spot trading is similar to contract trading, both of which use leverage to increase positions with a view to magnifying returns. Investors need to provide collateral to conduct leveraged trading while bearing the risk of liquidation. In addition, leveraged spot trading involves borrowing money from the lending market to go long/short, which requires paying an hourly interest before closing the position. However, users can invest in leveraged ETF tokens on Gate.io without providing collateral or borrowing money. They therefore face no liquidation risk and do not need to pay interest, but have to pay a fixed daily management fee.

Pros of leveraged ETF tokens

Leveraged gains

Leveraged tokens adopt a position adjustment mechanism. In a one-sided market (whether it is long or short), a position adjustment mechanism will be executed to automatically increase the profitable position, resulting in a compound interest income.

Free from liquidation

Leveraged ETF tokens do not require collateral and are therefore free from liquidation. However, if you are conducting contract trading with a high leverage ratio, you may find your positions being fully liquidated when the price fluctuates heavily.

Further, if the market price moves in an opposite direction to the leveraged ETF tokens, the position adjustment mechanism will be triggered to automatically reduce the position to stop losses.

Easy to use

Leveraged ETF tokens are traded in the same way as spot tokens. Just buy the leveraged tokens and sell them at a higher price. Compared with spot tokens, leveraged tokens generate a higher rate of return and eliminate the need to pay attention to changes in collateral and the leverage ratio.

Cons of leveraged ETF tokens

High risks

Although leveraged ETF tokens can generate higher yields than spot trading and are free from liquidation, they need to bear magnified losses if the asset price goes in a trend opposite to the leveraged token they purchased.

Not a good fit for long-term investment

Leveraged ETF tokens are more suitable for professional investors to hedge risks or make profits from short-term investments in a one-sided market. Due to the position adjustment mechanism, the value of leveraged ETF tokens will reduce in a volatile market. For example, if the market price of BTC rose by 10% yesterday and then fell by 10% today, the position adjustment mechanism will be executed to automatically increase the position that is rising and reduce the one that is falling. This will hence incur losses.

Management fees required

Funding fees and interest on the borrowed tokens are not required for leveraged ETF tokens on Gate.io, but a daily management fee of 0.1% (equivalent to an annual interest rate of 30%) of the contract position value is required.

When to invest in leveraged ETF tokens?

Cryptocurrencies face large ups and downs, especially when leverages are applied. Therefore, leveraged ETF tokens are more suitable for traders who are used to the volatility of the cryptocurrency market, or for professional investors to hedge risks or make short-term investments.

Due to the daily position adjustment mechanism, the value of leveraged ETF tokens may be reduced in a sideways market. Therefore, it is not advised to hold leveraged tokens for a long period or apply investment strategies like Dollar Cost Averaging (DCA).

Leveraged ETF tokens will bring leveraged gains. To participate, users generally only need to invest a small number of funds. In a one-sided market (that is, a market with prices unilaterally rising or falling), leveraged ETF tokens will automatically yield decent returns from the compound interest.

In addition, positions of leveraged ETF tokens will be automatically reduced when losses occur. They can also be used as a hedging tool similar to insurance. For example, when the leveraged token you hold has just spiked and brought your huge profits, you may choose to buy a small amount of short ETF leveraged tokens to lock in the profits. If it continues to rise, your short positions will only cause very limited losses. If it falls, you will be partially compensated, just as insurance will do.

Leveraged tokens can also be used by combining grid strategies to earn from short-term volatility. For example, if the underlying asset with a volatility ratio of 80% is expected to generate an annual rate of return of 25%, then the 3X leveraged ETF tokens will amplify the volatility and generate an annual rate of return of 75%. As long as the underlying price has not seen an obvious price trend, leveraged tokens can be used as a tool to amplify grid arbitrage gains.

Conclusion

If you think the price of a token is about to increase or decrease in a short term, you may choose to invest in the leveraged ETF token products on Gate.io. If you make a correct prediction, the ETFs will earn multiple returns for you. However, multiple returns are also accompanied by magnified risks. If the market trend is different from what you have predicted, your losses will spike exponentially.

Leveraged ETF tokens are regarded as a convenient tool for professional investors and traders. Gate.io provides 3X and 5X leveraged tokens that track given underlying assets. The ETF funds are managed by Gate.io and are free from liquidation. More importantly, the position size is automatically adjusted according to the profit and loss. Users only need to pay attention to the rise and fall of the market, without worrying about other issues such as collateral, the increase or decrease of positions, etc. Making good use of leveraged ETF tokens will help you avoid value reduction in a falling market and obtain returns when the market gets better.