The US Securities and Exchange Commission (SEC) issued warning letters to various exchange-traded fund (ETF) providers, putting a halt to applications for leveraged ETFs that exceed 200% exposure to the underlying asset.
ETF issuers Direxion, ProShares, and Tidal received letters from the SEC referencing legal clauses under the Investment Company Act of 1940.
This regulation limits the exposure of investment funds to 200% of their value-at-risk, determined by a “reference portfolio” of unleveraged underlying assets or benchmark indexes. The SEC stated:
“The fund’s designated reference portfolio provides the unleveraged baseline against which to compare the fund’s leveraged portfolio for purposes of identifying the fund’s leverage risk under the rule.”
The SEC instructed issuers to lower their leverage levels in line with existing regulations before their applications would be assessed, dampening prospects for 3-5x crypto leveraged ETFs in the US.
On the same day the letters were sent, SEC regulators publicly posted them in an “unusually swift action” that indicates officials are eager to address their concerns about leveraged products with the investing community, as noted by Bloomberg.
Following a flash crash in October that caused $20 billion in leveraged liquidations, the crypto market experienced a significant downturn, igniting discussions among analysts and investors regarding the risks associated with leverage and its impact on the crypto sector.
Related: Vanguard’s 50M+ clients will soon have access to crypto ETFs
Leverage in crypto escalates, magnifying gains, losses, and depressing markets
“Leverage is clearly out of control,” analysts from The Kobeissi Letter commented in light of the SEC warning letters.
According to crypto analytics platform Glassnode, crypto liquidations have nearly tripled in the current market cycle.
During the previous cycle, liquidations in the crypto futures market averaged about $28 million for long positions and $15 million for shorts daily.
The current cycle is exhibiting approximately $68 million in long liquidations and $45 million in short liquidations per day, according to Glassnode.
Following the 2024 presidential election in the United States, demand for leveraged crypto ETFs surged, anticipating improved regulatory conditions for crypto in the US.
While leveraged ETFs do not face margin calls and automated liquidations like leveraged crypto derivatives, they can still inflict significant damage on investor capital during a bear market or even a sideways market, as losses accumulate more rapidly than gains.
Magazine: Stop piling into leveraged Bitcoin ETFs and consider this instead
