The U.S. Securities and Exchange Commission (SEC) is taking a firm stance against high-leverage crypto exchange-traded funds (ETFs), directing issuers to significantly reduce the leverage in their proposed products before applications will be considered. The regulatory body cited concerns over the substantial risks these instruments pose to investors.

In a statement, the SEC explained that a fund’s leveraged portfolio must be compared against an unleveraged baseline to properly identify its risk. In an unusually swift move, regulators published warning letters to issuers on the same day they were sent, a clear signal to the public about the agency’s serious concerns regarding leveraged crypto products.

Surging Liquidations Underscore Leverage Dangers

The SEC’s intervention comes as the crypto market grapples with the fallout from excessive leverage. A recent flash crash in October triggered $20 billion in liquidations, marking the most severe single-day liquidation event in the industry’s history. This event sparked intense discussion among analysts about the systemic risks posed by high-leverage trading.

Data highlights a dramatic increase in this trend. According to analysis platform Glassnode, daily liquidations in the crypto futures market have nearly tripled in the current market cycle. While the previous cycle saw average daily liquidations of about $28 million in long positions and $15 million in shorts, the current cycle is seeing approximately $68 million in longs and $45 million in shorts liquidated each day.

Despite the clear risks, demand for leveraged crypto ETFs surged after the 2024 U.S. presidential election, fueled by anticipation of a more favorable regulatory climate. While these ETFs aren’t subject to the same margin calls and automated liquidations as crypto derivatives, they carry their own significant dangers. In a bear or even a sideways market, losses can compound much more quickly than gains, potentially leading to severe capital erosion for investors.

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