Index Coop, a decentralized index token provider, has launched its 2x leveraged Ether index token (ETH2x-FLI-P) on the Polygon network.
These tokens allow users to access leverage while mitigating liquidation risks by holding the token in their Ethereum wallets. Despite being billed as reducing the risks associated with leverage, the instruments can behave unpredictably during choppy market action and quickly sustain compounding losses during down-trends due to rebalancing.
For example, Binance’s SUSHUP leverage token experienced a 93% daily loss during May, despite having posted strong returns during the preceding bullish market conditions. Commenting on leverage tokens to The Financial Times, Stephen Kelso of institutional brokerage firm ITI Capital described the instruments as offering retail investors “rope to hang themselves.”
ETH2x-FLI-P is the latest addition to the small but growing sector of decentralized leverage tokens. The token uses the Aave Leverage Module (ALM) smart contract from Token Sets, which enables decentralized protocols to access leverage by utilizing Aave’s lending protocol.
Tokenholders are also able to earn trade fees and rewards for providing liquidity paired with Wrapped Ether on SushiSwap’s Polygon deployment while accessing reduced leverage exposure.
Unveiled on Dec. 10, ETH2x-FLI-P is a fully-collateralized ERC-20 token that allows users to access leveraged exposure to Ethereum by holding the index token in their wallet.
Index Coop already offers its 2x Flexible Leverage Index token on Ethereum’s Layer 1 (ETH2x-FLI). While there are many similarities between Index Coop’s respective Polygon and Ethereum-based FLI tokens, the team highlights several distinguishing factors between the two.
Index’s Ethereum-based token utilizes Compound to rebalance at 24-hour intervals, while the Polygon deployment utilizes Aave every four hours. The Polygon token also utilized Wrapped ETH rather than Ether as its underlying asset. While both tokens target a leverage ratio of 2x, the Polygon version fluctuates between 1.7x and 2.3x compared to the ETH2x-FLI’s 1.8x and 2.2x
ETH2x-FLI-P holders can also provide liquidity paired with Wrapped Ether on SushiSwap, allowing them to effectively access 1.5x leverage while also earning trade fees and LP incentives in the form of SUSHI and MATIC tokens.
While leverage tokens reduce liquidation risks, Index Coop emphasized that leveraged token holders may experience “volatility drift” — a condition where sustained price swings in both directions result in FLI’s performance diverging from the 2x leverage target due to its variable margin and perpetual rebalancing, especially over the longer term.
Index Coop writes that FLI tokens should perform predictably in positive market moves, with returns expected to track the 2x target “during steady upward price movements.”
However, the tokens will perform “less predictably” in choppy markets, with returns likely to deviate from the the 2x target during range-bound or sideways price action, and divergence increasing alongside volatility.
Index Coop urges users to exercise risk management when trading the tokens, warning that volatility drift can reduce the positive impact of leverage during bullish market conditions.
“FLI becomes a riskier asset to hold over time,” Index adds.
A price chart for ETH2x-FLI demonstrates the risk of volatility drift, with Ether’s local November high seeing the token trade for two-thirds of its early May all-time high despite Ethereum’s spot markets surging into new record highs during November that surpassed May’s top by nearly 11%.
FTX’s 3x leverage ETHBULL tokens offer an even more stark example of volatility, topping out at roughly $3,200 in November after trading for nearly $30,000 in May.
Index Coop is not alone in offering leveraged tokens, with several other leverage tokens on the market offering varying degrees of centralization.
FTX’s ERC-20 “BEAR,” “BULL,” and “HEDGE” tokens were among the first leverage tokens to gain widespread attention after launching in 2019 and then securing listings on rival exchange Binance in early 2020.
However, Binance would remove the tokens by the end of March in the same year, with chief executive Changepn Zhao stating that many users had ignored warnings relating to the impact of volatility on their valuation, resulting in users racking up significant losses.
“They are some of the most actively traded token, it is bad for business to delist them. Not an easy choice. But … Protecting users comes first,” he tweeted.
Despite his comments, Binance would introduce its own leverage tokens that target a margin ratio of between 1.5x and 3x in May of the same year. Many other centralized exchanges have since moved to introduce their own leverage token products, including Huobi, OKEx, Bittrex, and Poloniex. The price of FTX’s 3x BULL tokens has experienced extreme volatility this year
Arbitrum-based TracerDAO’s leverage tokens went live with its September launch, allowing users to hold tokens representing either 1x or 3x shorts or longs tracking either Bitcoin or Ethereum.
Users can mint or burn tokens in exchange for USDC every hour using Tracer’s perpetual pools. Like Index Coop’s products, Tracer’s perpetual pools tokens are also DEX-tradable. Users can also stake their tokens to earn Tracer’s governance token TCR.
Phoenix Finance also launched leveraged tokens on the Binance Smart Chain, Polygon, and Wanchain, and supports a variety of altcoins in addition to BTC and ETH. The protocol uses its own lending pools to support the tokens.