Overview
In late 2025, staff at the U.S. Securities and Exchange Commission sent nearly identical warning letters to nine ETF issuers, including Direxion and ProShares, effectively freezing a wave of applications for 3x–5x leveraged ETFs tied to single stocks, sectors, and crypto assets such as Bitcoin and Ethereum. Citing Rule 18f‑4’s value‑at‑risk cap and insisting that the true, unleveraged underlying asset must be used as the “designated reference portfolio,” the staff signaled that new ETFs cannot legally target more than 200% exposure. The letters forced issuers either to withdraw or redesign products that sought ultra‑high leverage just as crypto markets reeled from an October–November crash and heavily leveraged products posted outsized losses.
This episode is the latest turn in a longer struggle over how much leverage regulators will tolerate in mass‑market exchange‑traded products. Since adopting Rule 18f‑4 in 2020, the SEC has allowed a boom in 2x products and a historic surge in spot Bitcoin ETF assets, while repeatedly warning that complex, leveraged structures can devastate retail investors and magnify volatility. The new stance—holding the line at 2x even under a more crypto‑friendly Trump‑era SEC—will shape whether Wall Street can package 3x–5x exposure to speculative assets inside mainstream ETFs, or whether that kind of risk is pushed back into derivatives, offshore venues, and shadow banking instead.
Key Indicators
People Involved
Organizations Involved
The SEC is the main U.S. federal regulator for securities markets, including ETFs and other registered investment companies. It writes and enforces rules such as Rule 18f‑4, reviews ETF registration statements, and has the authority to block or condition new fund launches.
Direxion is a specialist provider of leveraged and inverse ETFs, widely used by active traders for tactical exposure to equities, sectors, and, more recently, crypto‑related assets.
ProShares is a major U.S. ETF issuer known for early leveraged and inverse funds on broad indexes (such as UltraPro QQQ) and for launching some of the first crypto‑linked ETFs.
Volatility Shares is a niche issuer focused on volatility and leveraged products, including earlier leveraged Bitcoin futures ETFs. In October 2025, it filed one of the boldest packages of ultra‑leveraged ETFs seen in the U.S. market.
BlackRock’s iShares platform operates the iShares Bitcoin Trust (IBIT), which rapidly became the largest Bitcoin ETF globally and a central pillar of the new crypto ETF ecosystem.
Timeline
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ProShares withdraws highly leveraged ETF plans
Issuer ResponseProShares formally withdraws registration requests for several 3x ETFs, including triple‑leveraged products tied to mega‑cap tech stocks and crypto‑related sectors, acknowledging the SEC’s stance and signaling that the initial wave of ultra‑leveraged filings is effectively dead on arrival.
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SEC sends similar warning letters to multiple ETF issuers
Regulatory ActionSEC staff issue nearly identical letters to eight other ETF sponsors, including ProShares, GraniteShares, and Tidal, pausing the review of applications for new highly leveraged ETFs seeking more than 2x exposure and explicitly questioning attempts to redefine reference portfolios under Rule 18f‑4.
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SEC staff letter to Direxion rejects 3x ETF leverage structures
Regulatory ActionThe SEC’s Division of Investment Management sends a letter to Direxion’s counsel stating that staff will not perform a substantive review of filings for ETFs seeking more than 200% leveraged exposure, clarifying that the funds must use their actual underlying assets as designated reference portfolios for VaR tests and urging Direxion to revise objectives or withdraw filings.
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Bitcoin and crypto ETFs suffer steep drawdown into November
Market EventBitcoin falls below $90,000—more than 25% off its October peak—with spot Bitcoin ETFs seeing multi‑billion‑dollar net outflows. Leveraged ETFs tied to a major bitcoin‑heavy corporation lose around 80–85%, highlighting the dangers of combining high leverage with volatile crypto‑linked equities.
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SEC says it’s ‘unclear’ whether 3x–5x ETFs comply with Rule 18f‑4
Public StatementDuring a partial government shutdown, SEC officials tell reporters that dozens of recently filed 3x and 5x leveraged ETFs may violate the 2x cap in the Derivatives Rule, pre‑signaling heightened scrutiny of ultra‑leveraged products.
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Volatility Shares files 27 ultra‑leveraged ETFs, including 5x crypto
Product FilingVolatility Shares submits a post‑effective amendment proposing 27 new ETFs with 3x and 5x leverage on Bitcoin, Ether, Solana, XRP and volatile U.S. equities, with an automatic effective date of December 29, 2025 absent SEC intervention.
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Crypto markets peak before October crash
Market EventBitcoin hits an all‑time high around $126,000, with spot Bitcoin ETFs recording billion‑dollar inflow days. Days later, a sharp October crash wipes out tens of billions in value, triggers massive liquidations of leveraged positions, and begins a multi‑month drawdown.
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SEC approves in‑kind creations/redemptions for BTC and ETH ETFs
Regulatory ActionUnder Chair Paul Atkins, the SEC authorizes in‑kind creation and redemption mechanisms for all spot Bitcoin and Ethereum ETFs, widely interpreted as a major crypto‑friendly policy move that further boosts ETF adoption.
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SEC approves first wave of spot Bitcoin ETFs
Product ApprovalThe SEC approves 11 spot Bitcoin ETF applications, enabling funds like BlackRock’s iShares Bitcoin Trust (IBIT) to list and kickstarting a historic inflow cycle that normalizes crypto exposure in mainstream portfolios.
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SEC allows first 2x Bitcoin futures ETF
Product ApprovalThe SEC permits the launch of the first 2x leveraged Bitcoin futures ETF, signaling that modestly leveraged crypto exposure is acceptable within the derivatives and VaR framework, but without yet addressing higher leverage or spot products.
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SEC officials warn about risks of single‑stock leveraged ETFs
Public StatementSEC’s Office of Investor Education and Commissioner Caroline Crenshaw issue statements flagging single‑stock levered and inverse ETFs as highly risky and potentially unsuitable for most investors, foreshadowing later leverage debates.
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SEC adopts Rule 18f‑4, modernizing derivatives regulation for funds
RulemakingThe SEC adopts Rule 18f‑4 under the Investment Company Act, allowing broader derivatives use by funds but imposing a VaR‑based leverage limit. The rule generally caps a fund’s VaR at 200% of a designated reference portfolio and effectively limits new leveraged or inverse ETFs to +/-2x exposure, while grandfathering existing over‑200% products.
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ESMA caps leverage on retail CFDs and crypto derivatives in EU
International RegulationThe European Securities and Markets Authority implements pan‑EU product‑intervention measures including strict leverage caps (down to 2:1 on crypto CFDs) and negative balance protection for retail clients, providing a reference point for leverage control in complex products.
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FINRA raises margin requirements on leveraged ETFs
Regulatory ActionFINRA adopts Regulatory Notice 09‑53, increasing customer margin requirements for leveraged ETF positions and associated options to limit excessive retail leverage.
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FINRA warns brokers about leveraged and inverse ETFs
Regulatory WarningFINRA issues Regulatory Notice 09‑31 reminding firms of suitability and disclosure obligations for leveraged and inverse ETFs, noting that daily‑reset products are typically unsuitable for buy‑and‑hold retail investors.
Scenarios
De facto permanent 2x cap on U.S. ETFs
Discussed by: ETF trade press (ETF.com, Investing.com), Bloomberg and Reuters analysts, compliance attorneys
Under this scenario, the SEC’s December 2025 letters crystallize into a stable policy norm: no new ETFs are permitted to target more than 2x leveraged (or inverse) exposure relative to any underlying asset, whether equities, commodities, or crypto. Staff letters are followed by interpretive guidance or FAQs explicitly affirming that Rule 18f‑4’s 200% VaR limit must be measured against the actual unleveraged underlying, and that attempts to game the reference portfolio are unacceptable. Issuers quietly abandon 3x–5x proposals and refocus on 1x–2x products, options‑based ‘defined outcome’ funds, and volatility overlays. Ultra‑high leverage migrates to futures, swaps, and offshore ETPs, while U.S. ETFs remain relatively conservative. Retail losses are reduced, and systemic risk from ETF leverage is contained, but active traders complain about lost tools and push activity back into less transparent venues.
Industry challenge forces the SEC to revisit its interpretation
Discussed by: Securities lawyers, some issuer executives, libertarian‑leaning policy commentators
One or more issuers could litigate, arguing that Rule 18f‑4 allows more flexibility in choosing a designated reference portfolio or that the SEC’s de facto ban on >2x funds is an arbitrary policy shift requiring formal rulemaking under the Administrative Procedure Act. A court could require the SEC to reopen its derivatives rule or at least conduct a notice‑and‑comment process clarifying leverage treatment for ETFs. This path would be slow and uncertain: few issuers may want to jeopardize relationships with the SEC, and courts have historically given wide deference to the agency on risk‑management rules. But if a well‑resourced issuer or trade association perceives significant revenue at stake, or a future administration becomes even more deregulatory, a legal or political challenge could force the SEC to articulate clearer, possibly more permissive standards for high‑leverage ETFs.
Congressional or political pressure softens leverage restrictions
Discussed by: Pro‑crypto lawmakers, think‑tank reports focused on ‘financial innovation’ and U.S. competitiveness
Given a Republican administration and a political narrative that frames crypto and innovative financial products as engines of growth, Congress could seek to narrow the SEC’s discretion over leverage caps—perhaps by carving out exceptions for ‘qualified’ investors, authorizing higher caps for exchange‑traded products that meet enhanced disclosure and supervision standards, or directing the SEC to harmonize with looser foreign regimes. In practice, such legislation would face Senate gridlock and public‑opinion headwinds after visible crypto losses. Still, even credible legislative proposals could pressure the SEC to find compromise solutions, such as allowing limited 3x products with strict concentration limits and point‑of‑sale warnings, particularly if U.S. trading activity migrates offshore in response to the current crackdown.
Another crash leads to even tighter rules on complex ETFs
Discussed by: Systemic‑risk scholars, investor‑protection advocates, some former regulators
If another major crypto or equity drawdown reveals that even 2x ETFs can trigger feedback loops—through forced rebalancing, liquidity stress, and retail margin calls—the political and regulatory response could be to tighten the screws further. The SEC, FINRA, and possibly the Financial Stability Oversight Council might restrict sales of leveraged and inverse ETFs to certain account types, mandate enhanced margin and concentration limits at broker‑dealers, or revisit the grandfathering of legacy >2x funds. International precedents like ESMA’s CFD leverage caps and product bans would provide a template. In this scenario, the December 2025 letters look like an early warning shot in a broader move to de‑risk the ETP complex, not just a cap at 2x.
Workarounds shift leverage into structured notes and offshore venues
Discussed by: Sell‑side research, offshore ETP providers, crypto‑native derivatives exchanges
If U.S. ETFs are locked at 2x, demand for higher leverage is unlikely to disappear. Banks and non‑bank financial firms can respond by offering structured notes, total‑return swaps, and offshore ETPs that simulate 3x–5x exposure without technically breaching U.S. ETF rules. Crypto exchanges already offer 50x–200x perpetual futures, and European and Asian markets list single‑stock and crypto ETPs with higher leverage. U.S. retail and semi‑professional traders may route activity to these less regulated products. The risk profile for households and the system may not markedly improve—only its locus shifts. In this world, the SEC is criticized from both sides: investor advocates say it hasn’t gone far enough, while market‑freedom advocates say it has simply offshored risk rather than eliminated it.
Historical Context
FINRA’s 2009 crackdown on leveraged and inverse ETFs
June–December 2009What Happened
In the aftermath of the 2008 financial crisis, FINRA issued Regulatory Notice 09‑31, warning brokers that leveraged and inverse ETFs were complex, daily‑reset products often unsuitable for long‑term retail investors. It highlighted how compounding could cause these funds to dramatically underperform their stated multiples over time and reminded firms of stringent suitability, disclosure, and supervisory obligations. Later that year, FINRA followed up with Regulatory Notice 09‑53, raising margin requirements on leveraged ETFs and related options to curb excessive customer leverage.
Outcome
Short term: Broker‑dealers tightened controls on who could trade leveraged ETFs and for how long, and some firms curtailed retail access altogether. The products remained available but became more closely associated with short‑term trading and speculation.
Long term: Regulators and courts developed a strong record treating leveraged ETFs as complex products demanding special care. This set a precedent for today’s SEC stance that ultra‑leveraged ETFs pose outsized risks and require structural limits rather than relying solely on point‑of‑sale disclosures or broker supervision.
Why It's Relevant
The current SEC campaign builds directly on a decade‑plus of skepticism about complex, leveraged ETPs. FINRA’s experience shows that suitability and margin rules alone did not prevent retail harm, supporting the SEC’s view that hard structural caps like Rule 18f‑4’s 2x limit may be necessary.
ESMA’s leverage caps on CFDs and crypto for EU retail investors
2018–2019What Happened
In 2018, the European Securities and Markets Authority used its product‑intervention powers to ban binary options for retail clients and to impose strict leverage caps on contracts for difference (CFDs), with limits ranging from 30:1 on major FX to 2:1 on cryptocurrencies, along with negative balance protection and standardized risk warnings. ESMA later allowed these temporary measures to lapse after national regulators implemented similar rules across EU member states.
Outcome
Short term: Retail CFD trading volumes declined, and many high‑leverage offerings were curtailed or pushed toward professional‑client categories. Providers retooled products to comply with leverage caps and enhanced disclosures.
Long term: ESMA’s actions became a global reference point for managing complex, leveraged products sold to households. The measures demonstrated that regulators can and will use product‑level leverage limits to address systemic investor‑protection concerns, even at the cost of reducing product variety.
Why It's Relevant
ESMA’s approach parallels the SEC’s emerging position: rather than trusting disclosure alone, regulators set hard leverage ceilings for mass‑market products, especially where crypto and single‑stock volatility amplify risks. It suggests that the SEC’s 2x cap is part of a broader global trend toward constraining leverage in retail‑facing wrappers.
SEC’s 2020 adoption of Rule 18f‑4 and the shift to VaR‑based leverage limits
2019–2020What Happened
After years of case‑by‑case exemptions for ETFs using derivatives, the SEC adopted Rule 18f‑4 in October 2020, creating a unified framework for registered funds’ derivatives usage. The rule requires most funds using significant derivatives to run a formal risk management program and to comply with an outer limit on leverage based on value‑at‑risk. In practice, this means a fund’s VaR cannot exceed 200% of a designated reference portfolio’s VaR under the relative test, effectively making 2x the maximum leverage for new ETFs, although a narrow band of older >2x funds was grandfathered.
Outcome
Short term: Issuers welcomed the clarity and used the new framework to launch a variety of 1x and 2x leveraged and inverse ETFs without bespoke exemptive relief, contributing to significant growth in complex ETPs—especially as crypto‑linked futures funds emerged.
Long term: Rule 18f‑4 turned the question of ETF leverage from a political or moral debate into a technical one about VaR, reference portfolios, and model assumptions. The December 2025 letters are essentially the SEC enforcing its original intent: ensuring that funds measure VaR against the true underlying asset and not a contrived benchmark that allows leverage to creep beyond 2x.
Why It's Relevant
Understanding Rule 18f‑4’s design is crucial to interpreting the current story. The rule was always meant to cap leverage at about 2x for new ETFs; issuers’ attempts to design 3x–5x products were, in effect, tests of how strictly the SEC would apply that limit. The 2025 crackdown suggests the Commission is returning to the rule’s original spirit after a period when some in the industry hoped for a looser interpretation.