Maintaining a constant leverage factor

The rebalancing mechanism is a key component for maintaining the leverage factor of a leveraged token within a targeted range.

Common perpetual futures exhibit frequent changes in their effective leverage. This occurs because price fluctuations of the underlying asset affect the margin-to-notional ratio. Leveraged tokens counteract this fluctuation by reactively rebalancing the margin-to-notional ratio as soon as an outer bound of the targeted leverage range is reached. This is achieved by directly adjusting the amount of borrowed funds of the underlying perpetual futures contract.

The margin-to-notional ratio defines your effective leverage.

Fig. 2 illustrates a rebalancing event of an ETH 2x LONG token. The decline in ETH price by 7.5% from T0 to T1 leads to a 15% reduction in the margin. As a result, the leverage factor rises to 2.18x, approaching the upper limit of the target range. The keeper network detects this deviation and initiates the rebalancing event, reducing the borrowed funds by 15%. This rebalances the margin-to-notional ratio, thus resetting the leverage factor to 2x.

For a more detailed exploration of the implications of rebalancing, please consult the following section.

Effects of rebalancing

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