A Shortfall in Investor Expectations of Leveraged Tokens

Leveraged tokens (LVTs) are emerging crypto-assets primarily issued by centralized exchanges. The concept is borrowed from leveraged ETFs (LETFs) in traditional financial markets, which offer higher gains (and higher losses) relative to price movements in the underlying asset. Leverage is commonly used by short-term traders to amplify returns from daily market shifts. However, LVTs have been implemented differently from LETFs by exchanges in the crypto market, with variations across platforms. We examine the mechanics and constituent components of LVTs, demonstrating that the lack of a standard has resulted in deficiencies and unexpected technical and economic outcomes. To identify existing problems, we analyze more than 1,600 leveraged tokens from 10 issuers. Our analysis reveals that 99.9% of LVTs are centralized, with 80% lacking blockchain interaction, leading to transparency issues. Total supply information is difficult to access for 53% of them, and 41% appear inadequately backed at launch. Additionally, 97% of LVTs are vulnerable to front-running during well-known events, and they deviate from their stated leverage ratios more than LETFs, partly due to inconsistent re-leveraging processes and higher management fees. This work provides a framework for crypto investors, blockchain developers, and data analysts to gain a deep understanding of leveraged tokens and their impact on market dynamics, liquidity, and price movements. It also offers insights for crypto exchanges and auditors into the internal functionalities and financial performance of LVTs under varying market conditions.