More high-risk leveraged crypto ETFs hit the market

This week, a couple more leveraged funds to play crypto have hit the market.

Direxeion, well-known for its leveraged exchange-traded funds, launched a bullish and bearish product on Wednesday with aptly-tickered stocks: the Direxion Daily Crypto Industry Bull 2X Shares (ticker: LMBO) and the Direxion Daily Crypto Industry Bear 1X Shares (REKT).

The ETFs seek to track the performance of U.S.-listed securities that operate in blockchain technology, non-fungible tokens, decentralized finance and digital asset mining hardware sectors, among others. They will provide plus-200% or negative-100% daily exposure to core crypto infrastructure.

“Crypto equities are among the fastest-growing companies in the world, now representing an almost $3 trillion asset class,” Direxion Managing Director Edward Egilinsky said in a release. “LMBO and REKT provide focused exposure for traders to express their short-term conviction on companies building the future of a crypto-driven, decentralized economy.”

A leveraged exchange-traded fund, such as Direxion's latest offering, uses financial derivatives and debt to amplify the daily returns of an underlying security. Traditional ETFs typically track the securities in their underlying index on a one-to-one basis, while a leveraged fund may aim for a 2:1(or higher) ratio. 

After launching in January, the 11 Bitcoin BTC -1.14% ETFs have gathered  $16.59 billion  in net inflows and reached $50 billion in assets under management. Leveraged funds have also been  launched  or  proposed since then. Direxion’s newest leveraged products are the latest entry of highly volatile but potentially highly profitable ETFs. Last week, REX Shares and Tuttle Capital Management (i.e., T-Rex) added two ETFs to the fray with BTCL and BTCZ.

"By launching 2X leveraged and inverse Spot Bitcoin ETFs, we're arming traders with powerful tools to capitalize on Bitcoin's price swings like never before,” said Scott Acheychek, COO of REX Financial.

“T-Rex with 2x and -2x spot bitcoin ETFs which will challenge ProShares and VolShares, whose leveraged btc ETFs already have about $2b combined,” Bloomberg Senior ETF Analysts Eric Balchunas posted on X last week. “That's how good the getting is in this category right now.”

What are leveraged ETFs?

Leveraged ETFs are typically meant to be short-term plays for experienced traders because of the high risk involved. In fact, more than half of all leveraged/inverse ETF products ever launched in the U.S. had been liquidated as of April 2022 according to Morningstar data .

“Leveraged ETFs have been the subject of much consternation in traditional finance…but they also have the potential to generate staggering gains under particular circumstances, far more than would be naively inferred from their stated leverage multiple,” QSR analysts wrote in a recent report . “As a result, real examples of leveraged ETFs have ranged from complete wipeouts to staggering success stories.”

Over the past few years, some firms have launched single-stock leveraged funds to play the performance of market stalwarts like Apple, Nvidia and Tesla. One currently proposed fund from T-Rex would track the 2x performance of MicroStrategy, hardly a household name but one that surged nearly 250% over the past year and trades as a proxy for bitcoin.

If that fund were to be approved, Balchunas said “it would be most volatile ETF ever seen in US by far, the 'ghost pepper' of ETF hot sauce.” Matthew Tuttle explained his company’s reasoning behind the proposed fund.

“We definitely think there is a demand for it,” Tuttle said on Bloomberg TV. “There's a whole bunch of degens out there who love to trade this stuff.”

Leveraged funds impact on bitcoin

Given the plethora of ETFs now or soon-to-be on the market, could these have an impact on the price of bitcoin?

“I don't believe these leveraged funds will increase systemic risk to Bitcoin or the crypto market. They're simply too small to have that impact,” Louis Sykes, a senior crypto analyst with All-Star Charts, told The Block in an email.

“If you were just reading the headlines, one may assume that these recent funds might heighten market volatility,” Syke continued. “In reality, we've entered a new era for crypto markets over the last year, marked by audited counterparties, ETF exposure, and collateralized lending.”

With funds like BlackRock and Fidelity entering the bitcoin market, Sykes said this structural trend is poised to reduce bitcoin's volatility, even in the face of these leveraged funds.

“[L]everaged funds have a decay function, making them poor long-term investments but helpful vehicles for managing short-term price risks for skilled traders,” Sykes said. “Most traders who engage with these funds will get hurt, but this is not a new phenomenon. You see this reckless behavior all the time in financial markets, but it's unlikely to pose much of a risk considering its size.”