How the fall of “Three Arrows” or 3AC pulled crypto investors down

The cryptocurrency industry, which has over 19,000 virtual currencies, compared the current state of the market to the early years of the internet. However, industry players have stated that most of these coins will collapse.

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Back in March, Three Arrows Capital was managing around $10 billion in assets, making it one of the most famous crypto hedge funds in the world.

Now the firm, also known as 3AC, applied to bankruptcy court after falling cryptocurrency prices and a particularly risky trading strategy that combined to wipe out his assets and make it impossible for him to pay his creditors.

The chain of pain can only begin. 3AC had a long list of contractors or companies that spent their money on the firm’s ability to even stay afloat. The Cryptocurrency Market Has Fallen More Than $1 Trillion Since April, Led By The Fall bitcoin as well as ethereuminvestors who have bet on firms like 3AC are suffering the consequences.

Cryptocurrency exchange Blockchain.com is reportedly facing a blow to $270 million in 3AC loans.. Meanwhile, digital asset brokerage Voyager Digital filed for Chapter 11 bankruptcy protection after 3AC failed to pay the approximately $670 million it took out a loan from the company. Cryptocurrency lenders in the US Genesis and BlockFi, crypto derivatives platform BitMEX and FTX also suffer losses.

“Credit is being destroyed and revoked, underwriting standards are being tightened, solvency is being tested, so everyone is taking liquidity from crypto lenders,” said Nick Carter, a partner at Castle Island Ventureswhich focuses on blockchain investments.

The Three Arrows strategy was to borrow money from across the industry and then turn around and invest that capital in other, often nascent, crypto projects. The firm has been in existence for ten years, helping founders Zhu Su and Kyle Davis establish credibility in an industry populated by newcomers. Zhu was also one of the organizers of the popular podcast on crypto.

“3AC was supposed to be the adult in the room,” said Nick Bhatia, a professor of finance and business economics at the University of Southern California.

Court documents viewed by CNBC show lawyers representing 3AC’s creditors allege that Zhu and Davis have yet to engage with them “in any meaningful way.” The filing also claims that the liquidation process has not yet begun, meaning that the company does not have cash to pay creditors.

Zhu and Davis did not immediately respond to requests for comment.

Tracking falling dominoes

“A correction in risky assets combined with less liquidity has exposed projects that promised high volatile APRs, causing them to crash, such as UST,” said Alkesh Shah, global crypto and digital asset strategist at Bank of America.

The panic selling associated with the fall of UST and its sister token Luna cost investors $60 billion.

“The crash of terraUSD and Luna is the epicenter,” said USC’s Bhatia, who published a book on digital currencies called Layered Money last year. He described the collapse as the first domino to be caught in “a long nightmarish chain of leverage and fraud”.

This was reported by 3AC to the Wall Street Journal. she invested $200 million in Luna. Other industry reports said the fund’s risk is about $560 million. Whatever the losses, these investments turned out to be practically worthless when the stablecoin project failed.

The collapse of UST has eroded confidence in the sector and hastened the decline in cryptocurrencies that is already happening as part of a broader risk aversion.

3AC lenders demanded some of their cash back in the margin call stream, but the money was not there. Many of the firm’s counterparties, in turn, were unable to meet the demands of their investors, including retail holders who were promised a 20% annual return.

“Not only did they not hedge anything, but they evaporated billions of creditor funds,” Bhatia said.

Peter Smith, CEO of Blockchain.com, said last week in a letter to shareholders. viewed by CoinDeskthat his company’s exchange “remains liquid, solvent, and this will not affect our clients.” But investors have heard sentiment like this before – Voyager said the same a few days before declaring bankruptcy.

Bhatia said the cascade would hit any player in the market with significant risk of asset deterioration and a liquidity crunch. And there are so few consumer protections in cryptocurrency that retail investors have no idea what they will end up owning.

Voyager Digital customers recently received an email saying that it would be some time before they could access the cryptocurrencies stored in their accounts. CEO Steven Ehrlich said on Twitter that after the company goes through bankruptcy proceedings, customers with cryptocurrencies in their account will potentially receive a bag of sorts.

This could include a combination of the cryptocurrencies they own, the common stock of the reorganized Voyager, the Voyager tokens, and any income they may receive from 3AC. Voyager investors told CNBC they see little reason to be optimistic.

WATCH: Voyager Digital files for bankruptcy amid crypto lender solvency crisis