SEC's Stance on Leveraged ETFs
The U.S. Securities and Exchange Commission (SEC) has blocked several ETF issuers from launching products that offer more than 200% exposure to an underlying asset. The agency issued warning letters to prominent ETF providers, including Direxion, ProShares, and Tidal. The SEC cited rules under the Investment Company Act of 1940, which impose restrictions on the amount of leverage a fund can employ relative to its "reference portfolio." This reference portfolio serves as the unleveraged benchmark for measuring the fund's value-at-risk. According to the SEC's interpretation, the designated reference portfolio provides the necessary unleveraged baseline to compare against the fund's leveraged portfolio, thereby identifying the fund's leverage risk under the rule.
These letters directed the ETF issuers to reduce the leverage levels in their proposed products before their applications would be considered for review. This effectively puts a hold on 3x–5x crypto leveraged ETFs in the United States for the time being. The swift publication of these letters on the same day they were sent was noted by Bloomberg as an "unusually speedy move," indicating the SEC's intention to promptly inform the investing public about the inherent risks associated with high-leverage investment products.
Investor Takeaway
The SEC's communication is unambiguous: products offering exposure beyond 200% will not be approved. Crypto traders seeking 3x–5x leveraged ETFs will need to explore alternative avenues, such as offshore markets or derivatives, to achieve their investment objectives.
Factors Influencing the SEC's Focus on Leverage
This regulatory action follows a significant sell-off in the crypto market during October, which resulted in approximately $20 billion in liquidations. This event marked the worst single-day liquidation wave in the history of the crypto market and reignited discussions about the perils of excessive leverage in a market characterized by rapid and substantial price swings. Leverage utilization has seen a notable increase during the current market cycle. Data from Glassnode indicates that average daily long liquidations have surged from around $28 million in the previous cycle to approximately $68 million presently. Similarly, short liquidations have also risen, from roughly $15 million to $45 million per day.
Analysts at The Kobeissi Letter offered a direct assessment of the SEC's decision, stating, "Leverage is clearly out of control." The SEC's intervention also coincides with a period of growing demand for crypto-leveraged ETFs. Interest in these products intensified following the 2024 U.S. presidential election, as traders anticipated a more favorable regulatory environment and sought accessible methods for amplified exposure without resorting to offshore derivatives or margin accounts.
Comparing Leveraged ETFs and Crypto Derivatives
Leveraged ETFs operate differently from futures contracts or perpetual swaps. They do not utilize margin accounts, and their positions are not subject to liquidation through automatic collateral calls. However, these ETFs reset their exposure on a daily basis, a mechanism that can lead to capital erosion in volatile or sideways markets, rendering them unsuitable for long-term investment. Losses can accumulate rapidly when volatility increases, particularly in a market where sudden intraday price movements of 10–20% are not uncommon. Recent liquidation events underscore how swiftly positions can be unwound, even in the absence of direct leverage tokens or margin trading.
The SEC's concerns are rooted in this operational structure: leveraged ETFs mechanically track amplified exposure, and persistent volatility can distort returns in ways that many retail traders may not fully comprehend. The agency's letters suggest a belief that products exceeding the 200% leverage threshold possess structural risks that fall outside the scope of current regulations.
Investor Takeaway
While leveraged ETFs avoid margin liquidations, they are still susceptible to capital depletion under unstable market conditions. The SEC's decision to halt these applications highlights that leverage, whether through ETFs or derivatives, remains a critical concern in crypto trading.
Future Outlook for ETF Issuers and Crypto Traders
ETF providers may explore options to modify their filings to comply with the 200% leverage limit, mirroring the approach taken by traditional leveraged equity ETFs. Any products that propose leverage exceeding this threshold will remain on hold unless regulatory frameworks are updated. For crypto traders seeking amplified exposure, offshore derivatives and existing futures markets are expected to continue as the primary avenues until the SEC grants approval for higher-leverage ETFs, which appears unlikely in the immediate future.
This regulatory decision introduces an additional dimension to the ongoing discussions surrounding investor protection as the crypto markets integrate further with traditional financial systems. While spot Bitcoin and Ethereum ETFs have broadened mainstream access, the SEC's recent action demonstrates a clear demarcation of acceptable leverage limits before considering more intricate financial structures. Currently, the confluence of increasing leverage, heightened liquidation activity, and a regulatory cap on ETF exposure sets the stage for the subsequent phase of market structure discussions within the U.S. ETF industry.