Just days before Bitcoin plummeted below $40,000, and two months prior to his hedge fund’s implosion, Su Zhu, co-founder of Three Arrows Capital (3AC), sat for an interview with FTX, exuding an air of nonchalant confidence. “When there’s too much despair, you can start buying,” he stated impassively. “You don’t have to chase the despair.”
Table Content:
This unwavering optimism wasn’t uncommon in the “HODL” culture of the crypto community. However, Zhu wasn’t just another retail investor. He and his partner, Kyle Davies, helmed 3AC, a crypto hedge fund managing billions of dollars—a significant sum in the digital asset realm.
Beyond their financial clout, 3AC was deeply embedded in the crypto ecosystem. They were venture capitalists in prominent crypto startups, often managing their treasuries. They were active borrowers from major lending platforms and simultaneously shareholders in some of them. They were, in essence, a linchpin of the interconnected crypto market.
Zhu gained notoriety in 2018 by accurately predicting the end of the crypto winter. This track record fueled confidence in his bullish outlook, even as Bitcoin tumbled from its $68,000 peak in 2022 amidst rising interest rates and a flight from risky assets.
Fueled by borrowed capital, 3AC bet heavily on a crypto rebound. However, the market’s continued decline triggered a cascading series of failures, culminating in 3AC’s own collapse. By mid-June, they began missing margin calls, and on July 1st, with Bitcoin trading below $20,000, 3AC declared bankruptcy.
The Ripple Effect of 3AC’s Collapse
The fallout from 3AC’s implosion reverberated across the crypto landscape, leaving a trail of financial devastation.
- Voyager Digital, a New York-based crypto exchange, filed for bankruptcy in July, citing over $650 million in outstanding loans to 3AC.
- Genesis Global Trading reported a $2.3 billion loan exposure to the fallen hedge fund.
- Blockchain.com, a major crypto platform, faced a $270 million unpaid loan and resorted to laying off a quarter of its staff.
Many within the crypto community attribute the 2022 market crash to 3AC’s demise. The resulting sell-off erased over a trillion dollars in value from Bitcoin and other digital assets, as reported by New York Magazine. Sam Bankman-Fried, former CEO of FTX, asserted that 3AC bore “80% of the responsibility for the market’s downturn,” highlighting the immense trust the ecosystem had placed in them.
The extent of the damage inflicted by 3AC is staggering, particularly considering their claims of operating solely with their own capital. By mid-July, creditors had filed claims exceeding $2.8 billion, a figure expected to rise significantly. The firm’s extensive borrowing network included major lenders, wealthy investors, and even 3AC employees who deposited their salaries into a lending pool.
A Series of Miscalculated Bets
The seeds of 3AC’s downfall were sown in 2021 with a substantial investment in the Grayscale Bitcoin Trust (GBTC). GBTC allowed investors to gain exposure to Bitcoin without directly holding it. Its popularity led to its shares trading at a premium to the underlying Bitcoin.
3AC exploited this premium by borrowing Bitcoin, exchanging it for GBTC shares at a discount, and then selling those shares at the inflated market price. However, shares acquired directly from Grayscale were subject to a six-month lock-up period.
Despite recognizing the inherent risk, 3AC held onto its GBTC position, anticipating SEC approval for converting GBTC into an exchange-traded fund (ETF). This approval never materialized, and in the spring of 2021, GBTC began trading below the value of its Bitcoin holdings, inflicting significant losses on 3AC.
Compounding this setback, 3AC doubled down on risk with a $200 million investment in Do Kwon’s LUNA token in February 2022. LUNA’s spectacular collapse in May wiped out over $40 billion in market capitalization, leaving 3AC with a near-total loss on its investment.
The Unraveling and Aftermath
As the situation deteriorated, 3AC attempted to downplay the severity of its losses to lenders like Blockchain.com, even providing misleading assurances about its financial health. Instead of retrenching, 3AC sought further leverage, desperately trying to recoup losses through increasingly risky bets.
By late May, they were soliciting large Bitcoin loans from wealthy investors, offering exorbitant interest rates. This frantic attempt to “rob Peter to pay Paul” only exacerbated the impending crisis. As 3AC’s massive sell-offs to meet margin calls further depressed the market, a vicious cycle ensued, dragging down other investors and accelerating the crypto crash.
Amidst growing rumors and mounting panic, Zhu and Davies ultimately fell silent, ceasing communication with lenders, partners, and friends. Their disappearance triggered a frantic search for answers and assets, revealing a trail of deceit and financial ruin.
The collapse of 3AC serves as a cautionary tale of excessive leverage, risky bets, and the interconnectedness of the crypto market. The ensuing legal and regulatory scrutiny highlights the need for greater transparency and accountability within the industry. Creditors are pursuing legal action to recover losses, with Genesis Global Trading leading the charge with a $1.2 billion lawsuit. The full extent of the damage and the ultimate fate of Zhu and Davies remain uncertain.
