Leveraged trading implies trading with borrowed money to either speculate on a rising or falling market. This involves both pros and cons to consider. In fact, many retail traders, especially in crypto field, are highly motivated to maximize their returns in a short period of time, sometimes avoiding basic risk management principles. In addition to that, there is a widespread anomaly discovered in behavioural finance, which is a disposition effect (selling profitable trades to early and holding onto losing trades for too long). So putting this all together, disposition effect + leveraged trading + financial illiteracy creates a huge risk exposure. FTX trading is not an exception.
The nature of FTX tokens
In this article, we are going to discover FTX leveraged trading. So far, this has been a topic of much debate. To such an extent that the biggest cryptocurrency exchange, Binance, delisted this new cryptocurrency derivative product. However, we are not going to focus on rumours, price manipulation theories and so on. This is purely an educational article.
Basically, FTX tokens are tokenized leveraged positions with a built-in algorithm of automatic rebalancing. Rebalancing occurs as the price of the underlying asset (in this case, let’s consider ETHBULLUSD in which ETH is the underlying asset) is constantly fluctuating and to maintain the target leverage, FTX has to adjust the position accordingly.
To emphasize, FTX utilizes a primitive profit rebalancing mechanism on a rising market. From the risk management perspective, FTX’s leveraged reinvestment significantly boosts an overall risk exposure as it increases the position size when the market is rising and hence the liquidation price becomes closer. To compare, high-frequency automated trading bots like Bitsgap’s SBot have a much lower risk exposure as they are not using the leverage and can achieve much higher profit maximization due to optimized swing-trading mechanism.
Here is ETH/BTC backtest performance for the period of only 1 week to demonstrate how a balanced risk-return strategy should look like:
As stated on FTX:
“Thus, every day each leverage token reinvests profits if it made money. If it lost money, it sells off some of its position, reducing its leverage back to 3x in order to avoid liquidation risk”.
Let's visualize this effect:
As you can see on the screenshot above, there are 3 scenarios presented:
- The first scenario is when the starting price was 200, then the market went up to 210 and later reached 220. An ordinary 3x leverage position would only make 30% in profit. However, as the FTX reinvests profits, a total return of 31.4% is achieved, which makes it the out-performer in comparison with 3x leverage and 1x ETH.
- In the second scenario, the price moves upwards to 210 and then reverts back to 200. FTX has the worst performance, -1.4%. This happened because of the increased market exposure as a result of rebalancing. When the price moved up to 210 from 200, generated profit was used to buy more ETH at a higher price hence increasing the position and adjusting the averaged entry price. As the price moved back to 200, for FTX this is no longer an entry price and hence the return is negative.
- The third scenario is a falling market. 3x ETH demonstrated the worst performance, -30%, whereas FTX minimized the risk and achieved a -28.4% return as it was selling ETH on a falling market to maintain the target leverage and hence reducing risk exposure.
Bigger risks ≠ Bigger returns
Considering all of these scenarios, FTX outperforms ordinary 3x leveraged contracts as it reinvests profits on a bullish market, which results in a compounded effect. However, imagine if the market consequently reverted and started to fall drastically, your FTX position that was reinvesting profit and hence accumulating position size on a rising market would put you in the biggest risk. On a swing market, FTX trading is not optimal. On a falling market, FTX outperforms 3x leverage but still puts the trader in a huge risk.
The way automated trading bots perform on a falling market scenario in comparison with FTX is completely different. For instance, SBot uses the downside market to achieve an optimal averaged entry price in a base currency + to make a profit in a quote currency on every possible price swing regardless of the volatility.
See the example:
Companies flooding the market with leveraged products have their biggest interest in leverage commissions. Traders must pay a funding fee on a daily and sometimes even on an 8-hourly basis, like on Bitmex. Historically, a funding rate can reach insane levels. As of the 2nd of April, a daily funding rate on XRP was 0.4947%!
Now, apply this rate to your net asset value and that will be your fixed expense. That is another crucial FTX’s downside - it has an implied daily leverage fee.
You should bear in mind that FTX takes 0.03% of a daily management fee, which is charged on your net asset value. Basically, this is a fixed funding rate. Moreover, 0.1% of a redemption and creation fee applies to FTX leveraged token.
Putting all things together: “FTX’s leveraged reinvestment significantly boosts an overall risk exposure as it increases the position size when the market is rising” + “implied daily management fee” = Liquidation with every day becomes closer.
Disadvantages of FTX trading
To conclude, FTX trading is riskier than ordinary leveraged trading. This derivative is also not optimal for hedging. In addition, taking into account recent news around FTX delisting, this might significantly affect FTX trading. For you to note, current FTX 24h trading volume is nothing compared to Bitmex:
Another disadvantage of FTX leveraged token is that in order to cash-out you must spend some time:
“Destroy the token; cause the ETHBULL account to sell back the $30,000 worth of futures, and credit your account with $10,000”.
So if you are OK with FTX built-in auto-rebalancing mechanism that can only maximize your return on a rising market, but which significantly disrupts your risk exposure on a falling market, then here is the list of exchanges you can speculate with FTX.
At the same time consider Bitsgap automated trading bots to maximize your returns and hedge on a falling market. In our blog, you can find some use-cases.