Just a day ago, the crypto community was celebrating the turnaround of long-time crypto critic Vanguard Group when they announced they would now allow ETFs and mutual funds that hold crypto. Today, a fresh warning from the SEC has reversed the optimistic sentiment. The U.S. Securities and Exchange Commission (SEC) has issued warning letters to several exchange-traded fund providers, freezing applications for leveraged crypto ETFs offering more than 200% exposure to their underlying assets. Nine ETF prov ...

Core Insights - The SEC Rule 18f-4, adopted five years ago, regulates the use of derivatives in mutual funds and ETFs, requiring a "Derivatives Risk Manager" to calculate Value-at-Risk (VaR) for leverage testing [1][4] - Recent filings by VolatilityShares for 27 new single-stock ETFs with leverage from 3X to 5X indicate a growing trend in the ETF market towards higher leverage products [3][6] - The potential loophole in the rule allows funds to classify cash as derivatives, which could enable them to meet the VaR requirements while maintaining high leverage [5][6] ETF Market Trends - There has been a surge in new 3X ETF filings, with the current wave being distinct from previous attempts at higher leverage products [2][3] - Historical attempts at higher leverage ETFs, such as ForceShares and VelocityShares, faced regulatory challenges and were ultimately shut down [2][3] Regulatory Environment - The current regulatory environment is permissive, with the SEC potentially allowing new filings to go live if not explicitly rejected within 75 days [6][7] - The ongoing government shutdown may impact the SEC's ability to review and respond to these new filings, leading to a lack of oversight [7] Risks and Innovations - The appetite for leveraged products among retail traders remains strong, despite inherent risks such as counterparty risks and hidden financing costs [9][10] - The concept of perpetual futures in the crypto market presents a more efficient alternative to traditional leveraged products, which may influence the future of ETF offerings [10][11]