SEC Blocks Leveraged Crypto ETF Applications

The US Securities and Exchange Commission (SEC) has issued warning letters to several exchange-traded fund (ETF) providers, effectively halting applications for leveraged ETFs that provide over 200% exposure to the underlying cryptocurrency assets. ETF issuers like Direxion, ProShares, and Tidal received these letters, citing legal provisions under the Investment Company Act of 1940. This act limits the exposure of investment funds to 200% of their value-at-risk, as determined by a "reference portfolio" of unleveraged assets or benchmark indexes. The SEC clarified its stance, stating:
"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 has instructed issuers to reduce leverage levels to comply with existing regulations before their applications can be considered, thus dampening the prospects for 3-5x leveraged crypto ETFs in the US market. The SEC's decision to publicly release the warning letters on the same day they were sent to issuers signals a clear intent to communicate their concerns about leveraged products to the broader investment community, as reported by Bloomberg.

Market Volatility and Leverage Concerns

The crypto market experienced a significant downturn in October following a flash crash that triggered $20 billion in leveraged liquidations. This marked the most severe single-day liquidation event in the history of cryptocurrency, prompting extensive discussions among analysts and investors regarding the dangers of leverage and its impact on the market. The increasing use of leverage in the crypto space amplifies both gains and losses, potentially suppressing overall market stability. According to analysts at The Kobeissi Letter, "Leverage is clearly out of control," in response to the SEC’s recent actions. Data from crypto analysis platform Glassnode indicates that liquidations in the crypto market have nearly tripled in the current market cycle compared to the previous one. The current cycle is experiencing approximately $68 million in long liquidations and $45 million in short liquidations daily, a significant increase from the previous cycle's averages of $28 million and $15 million, respectively.

Demand and Potential Impact

Demand for leveraged crypto ETFs saw a surge following the 2024 presidential election in the United States, driven by expectations of a more favorable regulatory environment for cryptocurrencies. While leveraged ETFs are not subject to margin calls and automated liquidations like leveraged crypto derivatives, they can still pose a significant risk to investor capital, particularly in bear markets or even sideways trending markets, due to the accelerated compounding of losses.

Risk Warning: This article represents only the author’s views and is provided for informational purposes only. It does not constitute investment advice, investment research, or a recommendation to trade, nor does it represent the stance of the Markets.com platform. When considering shares, indices, forex (foreign exchange), and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and may not be suitable for all investors. Leveraged products can result in capital loss. Past performance is not indicative of future results. Before trading, ensure you fully understand the risks involved and consider your investment objectives and level of experience. Trading cryptocurrency CFDs and spread bets is restricted for all UK retail clients.

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