📉Volatiity Decay
The gradual erosion of a leveraged token’s value in sideways or choppy markets.
Last updated
The gradual erosion of a leveraged token’s value in sideways or choppy markets.
Last updated
TLDR
Leveraged tokens rebalance to keep leverage constant.
In trending markets, this compounds profits.
In sideways markets, repeated rebalancing locks in partial losses → volatility decay.
Volatility decay is just one form of decay. Borrowing interest, funding payments, and rebalancing costs also contribute to overall decay.
Uptrend: leverage is rebalanced upward → profits compound.
Downtrend: leverage is rebalanced downward → losses compound.
Sideways chop: leverage is adjusted up and down repeatedly, which locks in partial losses → the token value decays.
Even if the underlying asset ends up at the same price, the leveraged token can lose value because of these rebalancing effects.
Start: BTC = $100,000. A 3x BTC LT = $3.
Day 1: BTC falls -10% → LT token drops ~-30%. Leverage rebalanced down.
Day 2: BTC rises +10% (back to $100). The token does not return to $300, because the earlier rebalance locked in part of the loss.
Result:
BTC back to $100 (breakeven).
Token still below $300 (loss).
Info: This is volatility decay in action — sideways swings degrade value even if the asset ends up flat.
(Optional: add a chart here showing BTC down then back up vs 3x LT underperformance.)
Volatility decay is not the only cost for leveraged tokens. Other drag factors include:
Borrowing interest → applies to money-market tokens (e.g., Aave).
Funding payments → apply to perp tokens (e.g., GMX, Flat Money). Can be positive or negative.
Rebalancing transaction costs → small but continuous overhead.
Together with volatility decay, these shape the overall decay of a leveraged token.
High-volatility, sideways markets → largest volatility decay.
Strong trends → compounding dominates, decay effects are less significant.
Shorter holding periods → less exposed to decay.
Volatility decay is a natural outcome of maintaining constant leverage in sideways markets. It’s just one component of overall decay, which also includes borrowing costs, funding, and transaction fees.
Leveraged tokens are best suited for trending markets, not as long-term passive holds.
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