Three Arrows Capital Founders Cite 3 Key Crypto Trades That Blew Up the Firm

The two co-founders of the recently bankrupt crypto hedge fund Three Arrows Capital (3AC), Su Zhu and Kyle Davies, have broken their silence in a new interview with Bloomberg, published today. 

Zhu and Davies attribute 3AC’s rapid collapse to over-optimistic speculations on their part, with Zhu saying that they “positioned [themselves] for a kind of market that didn’t end up happening.” Davies echoed: ​​“We believed in everything to the fullest.”

In their lengthy postmortem, Zhu said it was “not a surprise” that 3AC folded and filed for bankruptcy, along with Celsius and Voyager. 

They weren’t the only ones to feel the chill of a crypto winter.

Lenders like Vauld and BlockFi have been having liquidity issues, while some of the names at the top—like Coinbase, Gemini, OpenSea, and Blockchain.com announcing mass layoffs. 

Said Zhu: “We have our own capital, we have our own balance sheet, but then we also take in deposits from these lenders and then we generate yield on them. So if we’re in the business of taking in deposits and then generating yield, then that, you know, means we end up doing similar trades.”

The trades that sank the ship

In their interview, Su Zhu and Kyle Davies attribute 3AC’s collapse to over-exposure to Terra, staked Ethereum, and Grayscale’s Bitcoin trust. 

Zhu said in the case of Terra, he initially didn’t see any red flags: “What we failed to realize was that Luna was capable of falling to effective zero in a matter of days and that this would catalyze a credit squeeze across the industry that would put significant pressure on all of our illiquid positions.”

“We began to know Do Kwon on a personal basis as he moved to Singapore,” said Zhu. “And we just felt like the project was going to do very big things, and had already done very big things. If we could have seen that, you know, that this was now like, potentially like attackable in some ways, and that it had grown too, you know, too big, too fast.”

Another popular trade among the ailing crypto companies was staked Ethereum, or stETH. Every stETH will in theory be redeemable for one Ethereum after the network migrates to a proof-of-stake (PoS) consensus mechanism in September.

However, one of the knock-on effects of Terra’s collapse was that stETH began to miss its peg. 

This attracted opportunistic traders to bet against the token: “Because Luna just happened, it was very much a contagion where people were like, ‘OK, are there people who are also leveraged long staked Ether versus Ether who will get liquidated as the market goes down?’ So the whole industry kind of effectively hunted these positions, thinking that, you know, that because it could be hunted essentially.”

Zhu also attributed 3AC’s collapse to exposure to Grayscale’s Bitcoin Trust (GBTC), an investment product for institutional investors who want exposure to Bitcoin without the risks of directly holding it. GBTC is currently trading at a 30% discount to BTC.

Zhu and Davies ghosting?

Su Zhu alleged that the reason 3AC’s founders have remained virtually silent for the last five weeks was not because they were absconding with capital, but because they felt their very lives were threatened. 

“For Kyle and I, there’s so many crazy people in crypto that kind of made death threats or all this kind of noise,” Zhu said. “We feel that it’s just the interest for everyone if we can be physically secured and keep a low profile.” 

Last Tuesday, Zhu broke his month-long Twitter silence to post screenshots of a recent email from Advocatus Legal LLP, the firm hired by 3AC, that was sent to legal representatives of the firm’s liquidators, Teneo. 

In the letter, 3AC’s lawyers asked the liquidators at Teneo whether they mentioned in their July 8 filing to the U.S. Bankruptcy Court the “threats of physical violence” that the 3AC founders and their families were receiving.

So 3AC may be hiding from disgruntled investors, but they’re no longer hiding from the public.

There is no doubt that this is the end of the road for the hedge fund; for now, though, the pair are focused on meeting their obligations to creditors, and eventually, moving to Dubai, most likely due to its crypto-friendly regulatory approach. 

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