The crypto market is going through a rough patch, largely attributable to the bear market and Terra’s crash, which has had a negative domino effect.
Three Arrows Capital was once considered one of the most prominent hedge funds in the crypto space, participating in a variety of activities, particularly the funding of crypto startups.
Startup founders tried everything to get the attention of Three Arrows Capital (3AC), but the trend has changed.
Recently, the once-popular hedge fund that was always in the news for its investments in high-performing crypto firms and startups appears to be in trouble.
The hedge fund has now become a cautionary tale about what not to do in the cryptocurrency space.
This article explores in detail the reasons for the change in tide and the fall of Three Arrows Capital (3AC), analyzing how it all went wrong for this notable hedge fund.
TL:DR
- Three Arrows Capital (3AC) is a hedge fund firm founded by Kyle Davies and Su Zhu, both Columbia University alums and former Credit Suisse employees.
- The Terra Collapse has had a wide-ranging negative impact on both individuals and organizations, including 3AC.
- Greed is believed to have significantly influenced 3AC’s poor decisions.
- Three Arrows Capital was allegedly over-leveraged and ignored margin calls.
- Since this incident, there has been a global surge in calls for governments to improve their regulatory efforts regarding cryptocurrency.
What is Three Arrows Capital (3AC)?
Three Arrows Capital is a hedge fund firm founded by Kyle Davies and Su Zhu, both alumni of Columbia University. Both founders attended the university together and went on to work for the same banking firm, Credit Suisse. 3AC was founded in 2012, and before its woes began, it was rapidly ascending the ladder of success in the crypto space.
During its peak in the crypto industry, the company owned stakes in a number of platforms and companies, including BlockFi, AVAX, LUNA (LUNC), Solana, and Aave, among others. During that time, 3AC had over $18 billion in crypto assets, making it one of the leaders.
As a venture capital firm, they funded innovative crypto projects and greatly benefited from holding ETH, AVAX, and NEAR.
The news of 3AC being unable to meet lender margin calls spread throughout Twitter and was confirmed by the Financial Times. Since then, the hedge fund has continued to fall from the pedestal that it once occupied.
The effect of 3AC’s collapse was felt by some crypto firms like Voyager Digital. Three Arrows Capital’s inability to pay its loan to Voyager Digital contributed to the latter’s filing for bankruptcy.
What Are The Root Causes Of The Fall Of Three Arrows Capital (3AC)?
Rumors that 3AC was unable to meet its lender margin call spread throughout the industry, particularly on the crypto side of Twitter. Larry Cermak, VP of Research at The Block, mentioned this in a tweet while highlighting the issues that the crypto market was facing at the time.
“Rumors about 3AC margin called, Celsius illiquid and done, Terra blew up, a lot of funds lost like 90% of their capital, Coinbase fired 20% of all employees.”
The following are some reasons for the collapse of the once-famous hedge fund firm.
Terra Collapse
The Terra Collapse has had a wide-ranging negative impact on both individuals and organizations.
Three Arrows Capital was one of the companies hit hard by the collapse of Terra, its native token, LUNA, and the algorithmic stablecoin, UST.
The root cause of the Terra ecosystem crash is discussed briefly below.
“The Terra protocol designed the TerraUSD architecture to be linked to the Anchor Protocol. Anchor Protocol began by offering crypto enthusiasts a 20% interest rate if they deposited their TerraUSD with them. This was one of the factors that drove up demand for UST. During that period, more people began to hold UST to benefit from the high-interest rate, which was higher than the regular rates available in the crypto market.
Anchor Protocol decided to significantly modify the rate it offered its users in March 2022, converting the 20% standard rate to a variable rate. With the new variable rate, it was evident that the new return on investment (ROI) would fall below 20%. This rate modification irritated numerous holders, forcing them to leave Anchor and sell their UST and LUNA. ”
After the fall of LUNA and UST, 3AC’s problems began. The hedge fund firm decided to use the funds provided by investors to deposit into the Anchor Protocol.
According to reports, they made this decision without informing their investors.
When Anchor Protocol was still offering 20% returns on deposits, 3AC decided to use investor funds to purchase $560 million in locked $LUNA.
After the collapse of the Terra network, the fall in the value of LUNA (now LUNC) affected the worth of the locked LUNA. The $560 million LUNA token has dropped to $600.
3AC not only reportedly borrowed funds from its investors without their consent to put in Anchor Protocol, but they also sourced funds from “multiple funds and counterparties and put them into Anchor to generate yield without telling them. Their UST position was confirmed to be at least nine figures before the Terra depegging event. ”
Fatman Terra, a notable figure in the Terra Research Forum, also stated that 3AC took funds from various parties under the guise of using them for another purpose rather than depositing them on Anchor Protocol.
“More counterparties have reached out, confirming that 3AC offered them various treasury management plans—a few openly included Anchor, but most didn’t. 3AC also had exposure to USDD and they were forced to sell their position earlier this week, triggering a small depeg.”
In an interview with Bloomberg, Zhu, the co-founder of 3AC, blamed the Terra crash and the complacency created by the prolonged bull market for the collapse of his hedge fund firm.
High Leverage
Before its collapse, Three Arrows Capital (3AC) had experienced immense success, especially during the bullish conditions the crypto market enjoyed in early 2021. The hedge fund firm borrowed money from various crypto lending platforms, including Aave.
3AC reportedly deposited $245 million in $ETH in Aave, an overcollateralized lending platform, in order to obtain a $189 million loan.
According to an on-chain analysis twitter page,
“3AC has $245M of $ETH deposited on lending platform @AaveAave. From this, they have borrowed $189M in $USDC and $USDT. This puts their Loan-to-Value ratio at ~77%. They must keep this below 85%.”
The thread went on to state,
“At current collateral/loan values, 85% or liquidation of their $245M of ETH occurs when $ETH hits $1034.
Their options:
- Deposit more USDC/USDT to bring down the loan
- Add more $ETH
- Pump the price of $ETH. ”
3AC failed to do any of the above, resulting in the liquidation of their loans.
The organization’s inability to deposit more ETH collateral fueled rumors that 3AC was experiencing liquidity issues.
According to reports, 3AC also obtained a loan from Compound Finance, which was also liquidated when the collateral value fell below the specified threshold. Approximately 8,000 ETH was said to have been liquidated.
Three Arrows Capital may have had a reason for overusing leverage in the crypto market, despite the bearish market conditions at the time, but the consequences of this action impacted its chances of survival.
When the chips were down and the hedge fund firm faced margin calls due to its excessive use of leverage, 3AC ignored them.
This devolved into various liquidation events occurring across multiple crypto lending platforms.
According to the Head of Trading at 8Blocks Capital—whose firm had a partnership with 3AC—on Twitter, “What we learned is that they were leveraged long everywhere and were getting margin-called. Instead of answering the margin calls, they ghosted everyone. The platforms had no choice but to liquidate their positions, causing the markets to further dump. ”
The embattled venture capital firm has referred to the decision to be heavily leveraged and borrow or collect funds, only to use them for a different purpose as greed.
Expensive Spending of the Founders
Another factor that has been linked to 3AC’s downfall is the founders’ alleged excessive spending.
After a US district court froze 3AC’s surviving assets, a consulting firm, Teneo, published the first affidavit of Russell Crumpler on the 3AC debacle.
According to the affidavit, the founders of 3AC led lavish lifestyles, including the purchase of a yacht worth more than $50 million.
Su Zhu, a co-founder of the hedge fund firm, and his wife purchased two homes in Singapore worth $28 million.
What Are The Effects of 3AC’s Insolvency?
The insolvency of 3AC is having a negative impact on the cryptocurrency market. 3AC’s activities have caused a domino effect that is affecting its various stakeholders, including its investors.
It also impacted its lenders, such as Voyager Digital, who consequently filed for bankruptcy.
This incident has cast a bad light on the cryptocurrency market and has increased calls for stringent regulations to check the activities of cryptocurrency firms.
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