Regulators hit the brakes! SEC warning halts 3x and 5x high-leverage ETFs; crypto derivatives see a decline

The U.S. Securities and Exchange Commission (SEC) recently sent warning letters to nine ETF issuers, including Direxion, ProShares, and GraniteShares, officially hitting the pause button on proposed leveraged exchange-traded funds offering up to 3x or even 5x leverage. The SEC pointed out that the risk exposure of these products could violate regulatory limits on the amount of risk a fund can take relative to its assets. This move has already prompted at least one issuer, ProShares, to withdraw multiple applications, including for a 3x leveraged cryptocurrency product. Against the backdrop of the massive success of spot Bitcoin and Ethereum ETFs, this regulatory action has poured cold water on the frenzy of highly leveraged derivatives innovation, highlighting core concerns about retail investor protection.

Regulatory Red Card: SEC Rarely Halts High-Leverage ETF Approvals

After a period of relatively loose approvals for innovative ETF products, the U.S. Securities and Exchange Commission abruptly changed course, sending a strong risk warning signal to the market. Recently, the SEC’s Division of Investment Management issued nearly identical warning letters to nine fund companies, making it clear that it would suspend the review of a series of proposed high-leverage ETFs until key issues are resolved. These targeted products aim to provide leveraged returns of 3x or even 5x the daily performance of underlying assets like S&P indices, commodities, and even cryptocurrencies.

What makes this action particularly noteworthy is its speed and transparency. SEC staff publicly disclosed the warning letters on the same day they were written— a sharp departure from the norm, where such letters are typically released 20 business days after review. This “real-time disclosure” strongly signals that the regulator wants to make its concerns public quickly, preventing high-risk products from gaining further market momentum. This move marks the first time the SEC has drawn a clear line in the sand regarding “extreme” product trends after previously allowing a variety of crypto-related ETFs, private asset tools, and complex trading strategies.

Affected issuers include industry names like Direxion, ProShares, Tidal, and Volatility Shares, all known for leveraged and inverse products. Notably, Volatility Shares had applied to launch ETFs with up to 5x leverage to amplify daily returns on single stocks like Tesla and Nvidia, as well as cryptocurrencies like Bitcoin and Ethereum. Currently, there are no 3x or 5x single-stock ETFs in the U.S. market; SEC rules have long effectively capped such risk exposure at 2x leverage.

Risk Calculation Benchmark in Focus: What Exactly Is the SEC Worried About?

The SEC’s core legal basis for this intervention comes from Rule 18f-4 under the Investment Company Act of 1940. This rule requires that a fund’s risk value must be less than 200% of its “appropriate reference portfolio” value. The regulator’s concern is that these high-leverage funds may not be using reference benchmarks that fully reflect the extreme volatility of the assets they intend to magnify.

Put simply, the SEC suspects issuers might be playing “word games.” ETF strategist Todd Sohn points out that issuers are trying to break the 2x leverage limit by exploiting loopholes in the definition of “reference asset” to circumvent regulations. For example, if a fund aiming for 3x daily Bitcoin returns calculates its risk using a benchmark with insufficient volatility, it could severely underestimate its actual tail risk. In times of market turmoil, such underestimation could lead to catastrophic NAV losses, or even total wipeout from margin calls or forced liquidations.

The European market has already provided a cautionary tale. In October, a 3x short AMD exchange-traded product from GraniteShares was “wiped out” and forced to close after AMD’s stock price surged in a single day. This vivid example perfectly illustrates the fragility of high-leverage products in volatile markets. The SEC’s warning letters aim to prevent similar risks from erupting among U.S. retail investors, especially when the underlying assets are cryptocurrencies, which are already known for high volatility.

A Comprehensive Look at High-Leverage ETF Market Risks

Current Market Size: Total U.S. leveraged ETF assets have reached $162 billion, with trading volumes surging post-pandemic.

Representative Product Performance:

• Gains: The largest, $3.13 billion ProShares UltraPro QQQ ETF, aims for 3x daily returns on the Nasdaq 100 Index, up nearly 40% year-to-date.
• Crashes: The 2x long MicroStrategy stock ETF has plunged over 83% this year; the 2x long Super Micro stock ETF is down more than 60%; the 2x long cannabis ETF is down 59.4%.

Key Regulatory Rule: Rule 18f-4, requiring fund risk value (VaR) to be less than 200% of the reference portfolio value.

SEC Action: Simultaneously issued warning letters to 9 issuers, demanding strategy modifications or withdrawal of applications.

Sober Reflection Amid Crypto ETF Boom: Where Are the Boundaries for Derivatives?

This regulatory tightening comes amid an unprecedented boom in crypto ETF products. Since the approval of spot Bitcoin and Ethereum ETFs last year, a wave of applications for crypto-derivative and innovative products has followed. For example, issuers like Defiance have filed for products offering 3x long and short leveraged exposure to assets such as Bitcoin, Ethereum, and Solana. These products aim to replicate the success of spot ETFs, but with significantly higher risk.

The SEC’s warning letters specifically cover these proposed high-leverage crypto ETFs. This sends a clear message to the market: while regulators are open to spot crypto asset investment tools, they remain extremely cautious about complex derivatives with high leverage built on top of them. The agency is clearly distinguishing between “providing asset exposure” and “amplifying speculative risk.”

This move may temporarily slow the pace of crypto asset derivative ETF innovation, forcing issuers to redesign product structures to ensure their risk models can withstand regulatory scrutiny. In the long run, clear rules and boundaries are not a bad thing. They help prevent poor-quality, high-risk products from flooding the market, harming investors, and ultimately damaging the reputation of the entire crypto ETF sector. Healthy innovation needs to occur within an investor protection framework, and the SEC is attempting to define the physical boundaries of that framework.

A Warning to Investors: High-Leverage ETFs Are Not “Get-Rich-Quick” Tools

For retail investors—especially newcomers lured by crypto’s high returns—the SEC’s move is a timely risk education lesson. Leveraged ETFs use derivatives like futures and options to amplify returns. While they can deliver spectacular profits in a favorable market, their design has inherent flaws.

First, these products typically target “daily” returns. In choppy markets, due to the compounding effect of daily resets, long-term holders may see returns that diverge dramatically from a simple multiple of the underlying asset’s cumulative return, and may even experience significant decay. Second, extreme volatility can trigger forced liquidation risk. As noted in the European example above, investors could lose their entire principal overnight. Finally, the complexity and high costs (management fees, derivatives trading costs, etc.) are often obscured by the allure of outsized returns.

Investors must recognize that 3x or 5x leveraged ETFs are highly complex trading tools, better suited for sophisticated traders with deep derivatives knowledge who can closely monitor positions and withstand extreme losses—not for long-term investing or asset allocation. This is the SEC’s concern: these products may tempt amateur investors who do not fully understand the risks, leading them into a “high-risk and opaque” arena.

How Leveraged ETFs Work and Global Regulatory Attitudes Compared

How Do Leveraged ETFs Achieve “Multiplied” Returns?

Leveraged ETFs do not simply borrow money to buy more stocks or crypto. Their core mechanism is using financial derivatives (mainly swaps and futures contracts) to replicate the targeted multiple of daily returns. Fund managers adjust derivative positions daily to ensure the fund’s NAV changes by the set multiple of the underlying index or asset’s “daily” moves. This “daily reset” means that long-term holding experience can differ drastically from simply leveraging a single investment by three times. In highly volatile markets, compounding can cause the fund’s NAV to diverge significantly from the corresponding multiple of the underlying asset’s long-term performance.

Global Regulatory Attitudes Toward High-Leverage ETFs

1. United States: Currently, rules like Rule 18f-4 effectively cap traditional leveraged ETFs at 2x leverage. Products with 3x or higher leverage, especially those based on single stocks or cryptocurrencies, face extremely strict scrutiny and have not been approved to date.
2. Europe: Relatively permissive, allows exchange-traded products with 3x or even higher leverage, including those based on single indices, commodities, and stocks. However, there have been cases of products going to zero value due to market volatility.
3. Asia (e.g., Japan, Hong Kong): Generally more conservative. Japan allows leveraged ETFs but with strict regulation; Hong Kong also has some leveraged and inverse products, but the underlying assets are usually mainstream indices, with a cautious stance toward high-leverage products for highly volatile assets like cryptocurrencies.

Key Differences: The U.S. emphasizes preemptive risk control via unified risk value models, while Europe allows more product innovation but relies more heavily on market discipline and investor responsibility after the fact.

The SEC’s nine warning letters are like a fire alarm in the middle of an ETF innovation party. They are not meant to shut the party down, but to remind everyone: that 5x speed “fun machine” in the center may be overheating. As crypto assets gain mainstream acceptance through spot ETFs, building overly high and risky derivative structures on top will inevitably draw increased regulatory scrutiny over systemic risk and consumer protection. This battle is far from over; issuers may adjust strategies to comply, but the SEC’s red line is clear: financial innovation can be bold, but the bottom line for retail investor protection must be upheld. For the market, a temporary “cooling off” may bring more sustainable long-term development—after all, a healthy market needs not only heart-pounding speculation tools, but also a foundation of trust that allows wealth to grow steadily.