Three Arrows C[r]apital: liquidations, contagion, legal issues, conclusions and resources

Three Arrows Capital is a crypto hedge fund founded by high school friends Su Zhu and Kyle Davies — prominent figures in the crypto industry — in 2012.

Though its self-defined focus is on "providing superior risk-adjusted returns," the prominent entity has been — for lack of a better acronym — btfo as a result of massive declines in coin and token valuations, stETH trading at a discount, Terra’s high-profile implosion, the widening GBTC discount and its own dramatic over-leveraging in line with its apparent supercycle expectations.

==This article will continually examine the ongoing crisis with 3AC and its effects on the overall crypto industry, while also providing resources for readers to learn more.==

Though Su Zhu has frequently flexed its power and supposed financial strength on Twitter, Three Arrows Capital has reportedly failed to meet its obligations and answer margin calls with a variety of crypto platforms.

• 3AC’s positions on crypto exchanges FTX, Deribit and BitMEX have been liquidated.

  • Though the hedge fund also owes BitMEX roughly six million USD in collateralised debt, the effect on the three exchanges’ overall health may be minimal. (Perhaps even negligible.)

    • CEO Sam Bankman-Fried claims FTX is unaffected.

• It is widely assumed that crypto lender BlockFi — which, earlier this year, agreed to pay 100 million USD in penalties for failing to register its retail crypto lending product’s offers and sales with the United States Securities and Exchange Commission — also liquidated (or “hedged”) all of 3AC’s associated collateral after "a large client […] failed to meet its obligations on an overcollateralized margin loan."

  • BlockFi has since agreed to a 250 USD revolving credit facility from FTX — a signal some speculate is indicative of its insolvency.

• It is also widely assumed that Genesis liquidated 3AC after CEO Michael Moro tweeted that the institutional crypto trading, lending, derivatives, custody and prime brokerage company "mitigated our losses with a large counterparty who failed to meet a margin call to us earlier this week […] We sold and/or hedged all of the liquid collateral on hand to minimize any downside.”

• 3AC has also liquidated all of the stETH in one of its wallets. After dumping 5500 stETH for nearly 6.1 million USDT one day prior, it has sold another 14,118 stETH for roughly 13.5 million USDT in a pair of transactions. [1, 2]

• Questions are currently being asked regarding 3AC’s 38,888,888 GBTC shares.

• Voyager Digital LLC issued a notice of default to 3AC for failing to make payments on a 15,250 BTC and 350 million USDC loan. It intends to seek recovery from 3AC.

3AC reportedly borrowed heavily in early June — using stETH as collateral — without indicating its financial issues. The lenders seemingly did not conduct due diligence or accurately assess the risk involved with lending to 3AC.

As of the time of this writing, both Zhu and Davies have, more or less, disappeared from public view while failing to respond to various business partners.

==The TL;DR is that 3AC owes a lot of money to a lot of people.==

Three Arrows Capital’s blowout has caused secondary problems — or, to use Crypto Twitter’s favorite buzzword, "contagion" — for a multitude of industry participants. These problems come through direct business or investment with 3AC, and/or the related decreases in crypto prices.

• Finblox — which advertises "up to 90% APY on your crypto" — has imposed 500 USD daily / 1500 USD monthly withdrawal limits for all users as a direct result of Three Arrows Capital’s investment.

• DeFiance Capital is believed by some to be struggling after its founder tweeted the venture fund is "actively working to resolve the situation." (They also tweeted: "We are courageous adults.")

• Cai Wensheng of Meitu and LongLing Capital are selling thousands of ETH coins after being liquidated to the tune of nine figures.

• dYdX took the time to address speculation regarding 3AC’s investment. The crypto exchange stated that its "liquidity and exchange operations have not been and will not be affected by current or future developments involving Three Arrows Capital."

• Crypto credit platform Nexo claims to have no exposure to 3AC after denying it unsecured credit two years ago.

  • Nexo’s solvency has been called into question as the crypto lender published a cease and desist order on its own blog in reference to what it calls "malicious spreading of inaccurate, fake and unfounded information." It also outlined a defense against some allegations being made.

• Following speculation that As a result of Voyager loaning 320 million USD 15,250 BTC and 350 million USDC to 3AC, the crypto platform announced that it "signed a non-binding term sheet with Alameda Research to secure a revolving line of credit providing Voyager with access to further capital." The credit comes in the form of cash/USDC-based credit facility and 15,000 BTC coins.

• Babel Finance claims to have "no business with Three Arrows Capital," despite suddenly suspending withdrawals alongside 3AC’s collapse. The crypto financial services firm has liquidity issues and has conducted an emergency assessment of its business. It is coming to agreements regarding the repayment of debts.

  • There exists speculation that Babel Finance will soon be bankrupt.

• Despite calling itself "The only DeFi trading and staking protocol with Single-Sided Liquidity & 100% Impermanent Loss Protection," Bancor paused its Impermanent Loss Protection — citing "hostile market conditions." The team didn’t explicitly blame Three Arrows Capital (and/or Celsius), but wrote in an official blog post:

  These costs have been amplified by the recent insolvency of two large centralized entities who were key beneficiaries of BNT liquidity mining rewards as long-time LPs in Bancor V2.1. To cover their liabilities, these entities have rapidly liquidated their BNT positions and withdrawn large sums of liquidity from the system, while an unknown entity has opened a large short position on the BNT token on an external exchange.

  • Some believe that Bancor is both disingenuous and in deeper trouble than it is letting on — with its solvency called into question.

• CoinFLEX paused withdrawals on June 23, 2022 after "a long-time customer of CoinFLEX’s account went into negative equity." The self-professed "Home of Crypto Yield" was unable to auto-liquidate the position and "required the Individual to pledge stringent personal guarantees around account equity and margin calls in exchange for not being liquidated."

  • CoinFLEX now plans on launching a token called Recovery Value USD, or rvUSD, as a solution toward re-enabling withdrawals.

• BlockFi — as mentioned previously — may be facing insolvency after agreeing to a 250 million USD loan from FTX.

  • If BlockFi struggled to operate at a profit during a bull market, questions must be asked regarding its viability in a bear market.

• Crypto lender Celsius has reportedly been advised to file for bankruptcy as Goldman Sachs looks to raise funds in order to purchase its distressed assets.

==The TL;DR is that 3AC’s contagion is indeed high, with many entities directly impacted by its apparent insolvency. As a direct result, coin and token prices in the crypto market are currently in free-fall. Trust in lending platforms across the industry has also taken a hit.==

In an effort to save itself, Three Arrows Capital has hired advisers to help resolve its extensive legal and financial woes, while hoping to find a saviour in another firm and appease creditors.

• 3AC finds itself a defendant — alongside Terraform Labs (and Do Kwon and Nicholas Platias), Jump Crypto, Tribe Capital and others — in a class action compliant for allegedly violating of U.S. federal securities laws.

It is presumed that 3AC will face multiple legal battles in the months ahead.

Lessons will be learned from Three Arrows Capital’s high-profile implosion and industry-shaking fallout.

• One of the primary poisons being exposed in the current 3AC fallout is the irresponsible lending and poor risk management endemic among major crypto entities in the recent past — drawing comparisons to the 2007-2010 subprime mortgage crisis in traditional finance.

  • There are no government bailouts of too-big-to-fail crypto entities. Whereas we’ve seen TradFi failure forgiven — and, in some cases, rewarded — through The Emergency Economic Stabilization Act of 2008, it’s ultimately every man for himself in the crypto industry.

• Compound Finance founder Robert Leshner noted how the event highlights the need for decentralized finance, tweeting:

  Watching the implosion of UST, Celsius, 3AC, and (hopefully not) more, all of which are opaque and trust-based, reaffirms the need for *Decentralized Finance* more than ever.

  • FTX CEO Sam Bankman-Fried similarly shared that the 3AC situation couldn’t have happened on a transparent on-chain protocol, tweeting:

    FWIW 3AC/etc. couldn't have happened with an on-chain protocol that was transparent

  • In fact, core DeFi protocols — Curve, Uniswap, Aave, Balancer, Sushi, etc. — worked as intended under what may be considered maximum stress.

  • Embattled CoinFLEX also acknowledged that CeFi is "vulnerable to a lack of transparency."

• Trust is rapidly decaying with in the crypto lending sphere. Most industry pundits are in agreement that now may be a good time to withdraw your funds. (Not your keys. Not your coins.)

• A premium may soon be placed on protocols built with resilience against black swan events in mind — particularly due to the inherent volatility of the crypto industry and market.

• With 3AC blowing up shortly after Terra and alongside multitude of industry influencers, it has becoming abundantly clear that idol worship may best be avoided.

• Tether has proven resilient thus far, despite its CTO’s claims that it experienced a coordinated attack on its liquidity. Paolo Ardoino tweeted:

  In more than one month Tether processed 16B in redemptions (~19% of our total reserves), again proving that our operations, portfolio, banking infrastructure and team are solid and battle tested. […] Tether also reduced its commercial paper exposure from ~45B to ~8.4B and is set to phase it out in full in the coming months. All the expiring CP have been rolled into US Treasury bills, and we'll keep going till CP exposure will be 0.

==The TL;DR is, essentially, the old Bitcoin adage: “Don’t trust. Verify.”==

The crypto industry’s focus is firmly on Three Arrows Capital’s crisis and its effects on the market. Here are some resources where you can learn more:

• Definalist is tracking Three Arrows Capital’s portfolio via Notion.

• Mika Honkasalo discussed 3AC (and Celsius) in Unchained’s 364th episode, titled "Why Possible Insolvencies by Celsius and 3AC Could Spell Disaster for Crypto."

• Messari’s founder has shared its last publicly available screener for 3AC.

• A Twitter account called @3AnonCompany purports to be anonymous counterparties that worked with Su Zhu and Kyle Davies in the past. It claims to be "spilling the beans."