Performance of Leveraged Tokens

Essentially, you can think of a leveraged token as a procyclical / momentum-rebalancing strategy vault.

When the underlying token continues to rise, the leveraged token’s exposure increases through automatic rebalancing.

When the underlying declines, exposure is reduced to maintain the effective leverage close to the target leverage, while ensuring the token can never be liquidated.

Under this mechanism, leveraged tokens exhibit two primary effects:

1. Compounding Effect

In a trending market, leveraged tokens benefit from the compounding effect — their returns can exceed the target multiple of the underlying asset’s cumulative performance.

Example:

For a 5x SOL leveraged token, when SOL rises 1% per day for 5 consecutive days:

$$SOL_{gain} = (1 + 1\%)^5 - 1 = 5.1\%;\\ 5XSOL_{gain} = (1 + 5\%)^5 - 1 = 27.6\%$$

Here, the 5xSOL token’s total gain (27.6%) even exceeds 5 times SOL’s total gain (5 × 5.1% = 25.5%).

Likewise, during a continuous downtrend, the compounding effect works in the opposite way — the leveraged token’s losses are less severe than the simple multiple of the underlying’s decline

Example:

If SOL drops 1% per day for 5 days:

$$SOL_{loss} = (1 - 1\%)^5 - 1 = -4.9\%\\5XSOL_{loss} = (1 - 5\%)^5 - 1 = -22.6\%$$

Compared to a simple 5× multiple (5 × -4.9% = -24.5%), the actual loss of -22.6% is smaller.

👉 In trending markets, leveraged tokens tend to outperform their theoretical multiple returns due to the positive compounding effect.

2. Volatility Drag

However, in sideways or choppy markets, the situation reverses.

Leveraged tokens suffer from volatility drag — the performance decay caused by frequent rebalancing during price fluctuations.

Put simply, it’s the cost of repeatedly “buying high and selling low” in a volatile market.

Example:

For a 5xSOL leveraged token, if SOL’s daily returns are +1%, -1%, +1%, -1%, +1%, then:

$$SOL_{gain} = (1 + 1\%)^3 \times (1 - 1\%)^2 - 1 = 0.98\%$$

A simple 5× multiple would suggest a 4.9% gain, but the actual 5xSOL performance is:

$$5xSOL_{gain} = (1 + 5\%)^3 \times (1 - 5\%)^2 - 1 = 4.48\%$$

So, in a volatile market, leveraged tokens underperform due to this compounding loss — and the higher the volatility, the greater the drag.

Key Takeaway

Leveraged tokens are powerful short-term trading tools that magnify gains and removing liquidation risk.

However, they are not designed for long-term holding, as the volatility drag gradually erodes value in non-trending markets.

Traders should use them strategically — in strong trends, they can outperform; in chop, they decay.