Crypto Market Commentary 

5 April 2020

Doc's Daily Commentary


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Checkmate's Corner

FTX Leverage

Recently there has been some chatter regarding the FTX leverage token products and how these differ to trading leveraged futures products. There is lots of nuance to these products and as with all leveraged products, the house is usually the winner.

This week I ran some analysis to demonstrate some of the risks and opportunities of these leveraged products and how best to use or avoid depending on your strategy and approach.


First lets describe the nature of leverage. Leverage is quite misunderstood in crypto markets (most retail markets actually) and what the difference is between 2x, 10x and 100x leverage. In short, leverage means that the size of the position you hold is larger than the total capital you have available in your account.

When you buy a house on mortgage and you start with a 10% deposit, you are now 10x leverage long on the property market. You have borrowed 90% and are now liable to repay those costs with interest.

In a trading example, if you deposit $100 into Deribit which operates as default 100x leverage, you are able to open a position of $100 x 100 = $10,000 in size. This is equivalent to depositing a 1% down payment and allowing you to trade with the remaining 99%.

Now if you did open a $10k position with only $100 margin), as soon as price moved 1% against you, you will be liquidated. The reason is that the exchange will not let your loses exceed $100 under any circumstances (because they are then at a loss). That $100 is your maximum defined risk and 1% move against you on a $10k position = $100.

Therefore, the way to think about leverage in this example is that as you can open a position of any size but as soon as your losses equal your available cash margin, you will be liquidated.

The sensible way to utilise leverage is to use it as a mechanism for depositing only a small amount of capital exposed to the risks exchange hacks, defaults or general centralised failure. With only a small amount of capital at risk, you can still trade as if you have a larger account size so long as you deploy sensible risk parameters.

The correct way to utilise the above example would be to deposit $100 on the exchange and trade positions of $100 to $200 which means for a stop loss 1% below your entry, you stand to lose $1 to $2 of your account which is inside Doc’s wise 1-2% maximum loss account rule.

The difference with spot

So if you are depositing $100 and still trading $100 position sizes, why not just buy spot?

The reason is that in the above example, lets imagine you bought $100 of spot BTC and get stopped out for a 2% loss. You now only have $98. That is ok, but in your next trade, you can only buy $98 worth of BTC and thus your position size is forced smaller. However, the maximum you can lose is $100 if BTC goes to zero.

On a 100x exchange like Deribit, you can continue to open $100 positions and each 2% stop loss will cost you $2 from your account. The big difference is that whilst you can still lose a maximum of $100, BTC will be greater than zero when this happens when your leverage is larger than 1x.

Lets assume an example where BTC entry price = $6000.

If you go long at 1x leverage ($100 position) then every 1% move = 1% gain/loss and you get liquidated at BTC price of 0.

If you go long at 2x leverage ($200 position) then every 1% move = 2% gain/loss and you get liquidated at BTC price of $3000 (6000 – 6000/2 = 3000).

If you go long at 50x leverage ($5000 position) then every 1% move = 50% gain/loss and you get liquidated at a BTC price of $5888 (6000 – 6000/50 = 5880).

You can see how the difference between spot and leverage is that your liquidation point, the price at which you have lost your full margin of $100 is reached comes sooner with higher leverage.

FTX Leveraged Tokens

So now that we understand the details of leverage, we can understand more about the FTX leveraged tokens. These products represent a tokenized version of an underlying 3x perpetual LONG (for BULL tokens) or 3x SHORT (for BEAR tokens).

The advantage of these products is that you cannot lose more than your initial investment. I.e. if you buy $100 worth of BULL, the maximum you can lose is $100. The design means that when BTC moves up 1%, BULL moves up 3% and BEAR moves down 3% (and vice versa).

However, since these tokens are 3x leveraged, one would expect them to liquidate at around $4000 assuming an entry price of $6000. The reason they do not liquidate is because they have a mechanism of rebalancing built in every time price moves around 10% or daily, whichever comes sooner. This ensures that leverage is reset to 3x regularly and smooths out the effects of funding rates and futures premiums.

So these are reasonable fixed risk trades. However, they carry with them a counter intuitive risk factor that makes them dangerous instruments.


In the case of BULL, it is true that every 1% upwards in BTC will be an approximate 3% move upwards.

If BTC moves up 10% from $6000 to $6600, BULL will move from e.g. $100 to $130 (a 30% move), note that BULL does not need to be the same price as BTC.

Now this is great if you are in a trending market and on the right side of the trade. You are gaining amplified gains on a directional market with limited downside (your entry value). Thus, these instruments may be useful for when we enter a strongly trending market (BULL or BEAR).

Where these instruments fall down and amplify risk is when price moves against you or the market enters enter choppy conditions (like right now!).

If that 10% move up on day 1 and is then followed by a move down of 10% on day 2, after the rebalance, your position will lose 10% on the ‘gained position’.

BTC drops from $6600 to $5940 representing a 1% loss on the original entry price of $6000.

BULL drops from $130 to $91 representing a 9% loss on original entry of $100.

So you can see that the actual loss on BULL is not 3x it is 9x in this instance. Leverage works to the downside much harder than it does to the upside. The reverse is true for BEAR.

This is called convexity and is a phenomenon of leverage where the opposite direction to the leverage has amplified risk associated with each move. It is also called leverage decay because during choppy sideways markets, the spot price will just move sideways where as the down moves destroy value more than the up moves gain it. Leveraged tokens lose value in sideways markets.

Simulation of performance

To show how dramatic the gains and loses are on BULL, I simulated its performance over the entirety of Bitcoins price history. I used a system called Monte-Carlo simulation which basically takes past performance each day, multiplies each run by a small random factor and repeats for 50 runs.

This way we can see performance across 50 slightly different alternate universes would look like and determine a statistically robust outcome.

I had to run this calculation twice….

The first one, looks like this.

Notice how the chart just stops. That is because the first sell off at the peak of 2012 was so dramatic that BULL literally went to zero. Gone. If you rode BULL from an imaginary genesis price of $100Million per token all the way to the top of 2012, it would be worth $1 Trillion at the peak…


Poof. Gone. Zero. Zip. Nothing.

In one day. Hilarious. And Scary.

I also looked at BEAR…it didn’t even make it past 2010! We barely had a price for BTC or pizza to show for it before BEAR collapsed to zero.

So I ran the simulation with a maximum loss of 99% on any one day. This puts in a price floor in for BULL and stops the liquidation event. The reality is that there are mechanisms that stop the first scenario from happening so this next chart is more realistic.

There some good observations from this. The most obvious is that whilst BTCUSD spot price has been in an 11yr uptrend, BULL is in a perpetual downtrend. Even though it is 3x leveraged long and Bitcoin is a parabolic uptrend asset, the downside leverage is so big, it decimates the upside long term.

BULL has traded from $100Million to $2091 in this simulation. Solid ROI for the long HODL!

The next observation is probably more important, that during BTC bull markets, BULL posts spectacular gains, gaining orders of magnitude more value. But as the first simulation showed, you better exit before a strong pullback because otherwise, it is back to square one (aka zero).

It is like a game of beat the bomb, you want to take the cash prize and not be too greedy because those who wait too long get wiped out. Obviously stop losses and risk management play an important role in protecting capital.

Concluding thoughts

Whilst this analysis shows that these are not buy and hold long term assets, they can be very useful trend trading or swing trading assets. They do not perform in choppy or losing trend markets but they perform extremely well in trending markets.

As with all derivative products, keeping to good risk management and trading rules, you could trade any instrument successfully. These are no exception and I do believe the defined risk trade with no margin requirements are a benefit and quite useful and I have had success with BULL and BEAR to date.

What is most important is to appreciate the risks and realities of instruments. Leveraged tokens are short term instruments and if used correctly, it is possible to either hedge portfolios or take defined risk swing trades with intelligent stops to capture amplified gains in trending markets.

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