How the fall of Three Arrows, or 3AC, sent crypto investors back down
With over 19,000 virtual currencies in existence, the cryptocurrency industry has likened the current state of the market to the early years of the internet. However, industry players said most of these coins will collapse.
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As recently as March, Three Arrows Capital managed around $10 billion in assets, making it one of the most prominent crypto hedge funds in the world.
Now the company, also known as 3AC, is heading to bankruptcy court after falling cryptocurrency prices and a particularly risky trading strategy combined to wipe out its assets and leave them unable to repay lenders.
The streak of pain may have just begun. 3AC has had a long list of counterparties, or companies that have wrapped their money in at least the company’s ability to stay afloat. With the cryptocurrency market down more than $1 trillion since April, led by declines in bitcoin and ethereum, investors with focused bets on companies like 3AC are suffering the consequences.
Crypto exchange Blockchain.com is said to be facing $270 million in loans to 3AC. Meanwhile, digital asset broker Voyager Digital has filed for Chapter 11 bankruptcy protection after 3AC was unable to repay nearly $670 million it had borrowed from the company. Crypto lenders Genesis, US-based BlockFi, crypto derivatives platform BitMEX, and FTX are also experiencing losses.
“Credit is being destroyed and withdrawn, underwriting standards are tightening, solvency is being tested, so everyone is withdrawing liquidity from crypto lenders,” said Nick Carter, partner at Castle Island Ventures, which focuses on blockchain investments.
Three Arrows’ strategy involved borrowing money from across the industry and then going around and investing that capital into other, often start-up crypto ventures. The company has been around for a decade, helping give founders Zhu Su and Kyle Davies a measure of credibility in an industry populated by freshmen. Zhu has also co-hosted a popular podcast on crypto.
“3AC was supposed to be the adult in the room,” said Nick Bhatia, professor of finance and business economics at the University of Southern California.
Court documents reviewed by CNBC show that attorneys representing 3AC’s creditors claim Zhu and Davies have yet to begin cooperating with them “in any meaningful way.” The filing also claims that the liquidation process has not begun, which means there is no cash to make payments to the company’s lenders.
Cho and Davis did not immediately respond to requests for comment.
Track the fall of dominoes
The downfall of Three Arrows Capital can be traced back to the collapse of terraUSD (UST) in May, which was one of the most popular stablecoin projects linked to the US dollar.
The stability of terrestrial lockers relied on a complex set of code, with very little hard cash to support the arrangement, despite the promise that they would maintain their value regardless of fluctuations in the broader crypto market. Investors were incentivized – on an accompanying lending platform called Anchor – with an annual return of 20% on their underground holdings, A rate that many analysts have said is unsustainable.
“The correction of risky assets along with less liquidity exposed projects that promised unsustainable high APRs, leading to their collapse, such as the UST,” said Alkesh Shah, global crypto and digital asset analyst at Bank of America.
The panic sale associated with the fall of the floor cabinets and its iconic sister, Luna, cost investors $60 billion.
“The collapse of TerraUSD and Luna is ground zero,” said University of Southern California’s Bhatia, who published a book last year on cryptocurrency called “Financial Layers.” He described the crash as the first domino to fall into a “long, nightmarish chain of influence and fraud”.
3AC told the Wall Street Journal that it has invested $200 million in Luna. Other industry reports said the fund’s exposure to risk was about $560 million. Whatever the loss, this investment became almost worthless when the stablecoin project failed.
The implosion of underground treasuries has shaken confidence in the sector and accelerated the slide in cryptocurrencies already underway as part of a broader retreat from risk.
3AC’s lenders demanded some of their cash back in a deluge of margin calls, but the money wasn’t there. Many of the company’s counterparties, in turn, were unable to meet investor demands, including retail owners who promised 20% annual returns.
“Not only did they not hedge anything, but they also evaporated into billions of creditors’ money,” Bhatia said.
Blockchain.com CEO Peter Smith said last week, in a letter to shareholders seen by CoinDesk, that his company’s exchange “remains liquid and solvent and our customers will not be affected.” But investors have heard that kind of sentiment before — Voyager said the same days before filing for bankruptcy.
Bhatia said the chain puts any market player with significant exposure to the liquidity crunch and deteriorating assets. Crypto comes with so few consumer protection measures that retail investors have no idea what, if anything, they’ll end up owning.
Voyager Digital customers recently received an email indicating that it would be some time before they could access the encryption on their account. CEO Stephen Ehrlich He said on Twitter That after a company goes through bankruptcy proceedings, customers with crypto in their accounts are likely to receive some kind of bag grab of things.
This could include a range of cryptocurrencies they own, common stock in reorganized Voyager, Voyager tokens and any revenue they can get from 3AC. Voyager investors told CNBC they don’t see much reason for optimism.
WATCH: Voyager Digital files for bankruptcy amid crypto lender solvency crisis