Three Arrows founders describe ‘unfortunate’ collapse en route to Dubai

After five weeks on the run, the disgraced founders of Three Arrows Capital have detailed the spectacular collapse of their once-high-profile hedge fund, saying their clumsy cryptocurrency speculation resulted in cascading loan margin calls that should never have been made.

Su Zhu as well as Kyle Davis, both 35 years old, they first became friends in high school. They turned 3AC into a crypto trading giant before its collapse bankrupted creditors and exacerbated a sell-off that inflicted huge losses on family owners of bitcoin and other tokens. At times remorseful and at times defensive, Davis and Zhu, speaking from an unknown location, described a systemic failure in risk management, in which easy credit exacerbated the impact of misbetting rates.

They acknowledged that the collapse caused everyone’s pain, but mostly discussed the impact on others in the industry. Instead, they emphasized that they had suffered heavy losses, denying allegations that they pulled money out of 3AC before it all exploded. “People may call us stupid. They may call us stupid or delusional. And I will accept it. Possibly,” Zhu said. “But they will, you know, say that I hid the funds during the last period, when I actually put back more of my personal money. It is not true.”

The consultants responsible for the liquidation of the fund said in documents dated July 8 that Zhu and Davis did not cooperate with them and that the whereabouts of the founders are unknown. Zhu said that death threats forced them into hiding. “That doesn’t mean we haven’t talked to all the relevant authorities,” Zhu said in a phone interview with Davis and two lawyers from Solitaire LLP. “We’ve been in contact with them since day one.”

The two declined to say where they were, but one of the lawyers involved in the conversation said their final destination is the United Arab Emirates, which has become a hotspot for cryptocurrencies.

In an extensive interview, former Credit Suisse traders detailed the events leading up to their fund’s collapse, which in itself set off a chain reaction that cost institutions and small speculators billions of dollars.

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“The whole situation is unfortunate,” Davis said. “Many people lose a lot of money.”

Leveraged betting meets crypto winter

Lenders of a fund recently registered in the British Virgin Islands have filed paperwork saying they are owed more than $2.8 billion in unsecured claims. That figure is expected to rise significantly, court documents show. To date, liquidators overseeing the insolvency have gained control of at least $40 million worth of assets.

Zhu and Davis, long among the most vocal cryptocurrency bulls in an industry known for extremes, opened leverage-enhanced trades that put 3AC at the center of a series of explosions that rocked the crypto market as prices retreated from their highs this year. Last failure. “We positioned ourselves for a market that ultimately never came,” Zhu said.

“We believed in everything to the end,” added Davis. “We had all of our, almost all of our assets there. And then in good times we did our best. And then in bad times we lose the most.”

At the same time, they claim that they were not exceptions. They describe a confluence of interconnected one-sided bets and loan arrangements that collapsed simultaneously, resulting not only in the collapse of their fund, but in the bankruptcy, disaster, and bailout of firms such as Celsius Network, Voyager Digital, and BlockFi.

“It’s no surprise that Celsius and we and similar firms are having problems at the same time,” Zhu said. “We have equity, we have our own balance sheet, but we also take deposits from these lenders and then we get income from them. So if we’re in the business of taking deposits and then generating income, you know, that means we end up making similar deals.”

Zhu and Davis’ efforts to deflect blame stand in stark contrast to the couple’s previously ruthless campaign to support crypto assets and downplay critics. This week, nerves were again on fire with claims by creditors that the founders made a down payment on a $50 million yacht before the fund went bust. According to Zhu, this statement is part of a smear campaign.

The boat “was purchased over a year ago and commissioned to be built and used in Europe,” Zhu said, adding that the yacht “has a full cash footprint.” He dismissed the notion of living an extravagant lifestyle, noting that he cycles to and from work every day and that his family has “only two homes in Singapore”.

“We have never been seen in any club spending a lot of money. You know, we have never been seen driving a Ferrari or a Lamborghini,” Zhu said. “This kind of vilification of us, I feel, is just out of a classic play, you know when it happens, when the money explodes, then you know, it’s the kind of headlines that people love to play.”

Long Arm of the Moon

Davis and Zhu acknowledged the large losses associated with trading Luna and the now-defunct algorithmic stablecoin TerraUSD, saying they were caught off guard by the speed of the collapse of these tokens.

“What we didn’t realize was that Luna could drop to virtual zero in a matter of days and that this would be the catalyst for an industry credit crunch, putting significant pressure on all of our illiquid positions,” Zhu said.

Looking back, Zhu said, the firm may have been too close to Terra founder Do Kwon.

“We met Do Kwon personally when he moved to Singapore. And we just felt that the project was going to do very big things and had already done very big things,” he said, describing the firm’s miscalculations. “If we could see it, you know it looked like a potential attack in a way now, and that it grew too, you know, too big, too fast.”

“For us, it was very similar to the moment of LTCM, the moment of Long Term Capital,” Zhu said. “We had different types of deals that we all thought were good, and other people had those deals too,” Zhu said. “And then they kind of all got a super markdown, really fast.”

One of these transactions involved an Ethereum-related token called ETH, or stETH, designed to trade as a proxy for Ether and widely used in decentralized finance. Although each stETH is destined to be exchanged for one ether once the long-awaited updates to the Ethereum blockchain go into effect, the turmoil caused by the collapse of Terra has caused its market value to drop below that level. This in turn, Zhu said, forced other investors into deals that could benefit from the widening gap.

“Because Luna just happened, it was a lot of contagion where people thought, ‘OK, are there people who are also long Ether against Ether that will be liquidated if the market drops?’ Zhu said. “So the whole industry was effectively hunting those positions, thinking, you know, because she could be hunted.”

However, the fund could continue to borrow from large digital asset lenders and wealthy investors – as long as they didn’t blow themselves up.

After the collapse of Luna, Zhu said the creditors had “calmed down” with 3AC’s financial position and allowed them to continue trading “as if nothing had happened”. As the lawsuits have now shown, many of these loans required only a very small amount of collateral.

“So I just think that, you know, during this whole period, we continued to do business as usual. But then, yes, after the day when, you know, bitcoin went from $30,000 to $20,000, you know, it was very painful for us. And it was, it became a kind of nail in the coffin.”

Zhu said that “if we played our game more, we would see that the loan market itself can be a cycle and that, as you know, we will not be able to access additional loans at the time we need them. If, if that’s the case, you know it hits the fan.”

Blocked in GBTC


Another bullish trade that came back to bite 3AC was through the Grayscale Bitcoin Trust or GBTC. A closed-end fund allows people who can’t or don’t want to hold bitcoins outright to instead buy shares in the fund that invests in them. For a while, GBTC was one of the few crypto-currency products regulated by the US, so the market belonged to it alone. He was so popular that his stock constantly traded at a premium to the value of the bitcoins he held on the secondary market.

The shades of gray allowed large investors like 3AC to buy shares directly by putting Bitcoin in a trust. These GBTC holders could then sell the shares on the secondary market. This premium meant that any sales could generate attractive returns for large investors. At the time of the last filing at the end of 2020, 3AC was the largest holder of GBTC with a $1 billion position at the time.

However, the strategy had a night: shares bought directly from Grayscale were locked up for six months. And since the beginning of 2021, this restriction has become a problem. The price of GBTC has fallen from premium to discount — the stock was worth less than the bitcoin that backs it — as it faced stiffer competition from similar products. As the months went by, the discount got wider and wider, and the so-called GBTC arbitrage trading no longer worked, especially hurting investors who were using leverage to try and increase profits.

Part of their own success has helped promote both GBTC and the herd mentality in trading, according to Zhu and Davis.

“We managed to do it in the right window when it was a very big profit,” Zhu said. “And then, like others, they copied us into this deal later, and then they not only lost money, but also went into the red. Since everyone was doing that, the trust went into a discount, and then a much larger discount than anyone could have imagined.”

Risk free return
Responding to questions about what went wrong at the firm, Zhu cited an overconfidence spawned by a years-long bull market that affected not only him and Davis, but almost the entire industry’s lending infrastructure, where lenders saw their value rise through funding. firms. like him.

“There was always an understanding of what they were getting into—it was a risky business,” Zhu said. “For us, if you go to our website, we have always had massive crypto risk disclaimers. We have never positioned ourselves as risk-free, as a simple income.

When crypto markets first began to fall in May, “we met all margin requirements,” he said. “And, and so people realized that it involved risk.”

What’s more, the firm’s lenders “received huge benefits when we were doing well, because if we were doing well, they could say, look, I’m making $200 million a year from the Three Arrows financial business, let me 10 times multiplier.” he said. “And now my own company is worth $2 billion more. All these things. So the risk departments were very relaxed about the risks we were taking.”

So where from here? At the moment, two co-founders are moving to Dubai. Zhu’s main hope is to achieve a smooth and orderly liquidation of their complex ledger of personal assets.

“For Kyle and me, there are so many crazy people in crypto who have made death threats or made such a fuss,” Zhu said. “We think it’s just in everyone’s interest if we can be physically protected and keep a low profile.”

“Given that we planned to move the business to Dubai, we should go there soon to assess whether we will move there as originally planned, or if something else awaits us in the future,” Zhu added. “Things are very fluid at the moment and the focus is on helping creditors through the recovery process.”

As for Davis, “I have a feeling that my next year is planned for me,” he said.