As lender after lender in the crypto-space freeze assets and report massive losses on loans, most seem to have one thing in common – Three Arrows Capital.
The events began as the crypto-sector began a decline which would see $2 trillion of its $3 trillion market capitalization wiped from the books. Then in early May sister tokens Luna and TerraUSD collapsed. As they dropped in value, investors all looked to liquidate their positions at the same time, and the coins values dropped to zero. At least $55 billion was wiped out in the disaster.
Although initially thought to be an isolated event, this was rapidly revealed to be a contagion event as first, crypto-lender Celsius Network suspended withdrawals, preventing customers from getting access to their funds.
A few days later, Three Arrows announced that it had an exposure of almost $200 million to Luna, meaning it had almost all been lost. Shortly after, Voyager Digital, another crypto lender, announced that Three Arrows had just defaulted on a loan of $630 million that it had extended to it.
Then followed a wave of firms suspending withdrawals from customers at lenders like Babel Finance, CoinLoan, CoinFlex, and others.
Crypto-giant BlockFi had to let itself be sold to young crypto billionaire Sam Bankman-Fried, founder of the platform FTX.com, in a fire sale. Smaller lenders like Vauld saw the crisis extend to them, as crypto exchange Blockchain.com warned shareholders it was looking at a $270 million loss to Three Arrows.
Suddenly it was announced Three Arrows was to be liquidated. Voyager Digital and Celsius filed for Chapter 11. Of the others, customers still have no idea if they will ever see even a portion of their funds.
A new report indicates that the link between all of these companies is Three Arrows Capital, and it may have been responsible for much of the carnage. It would appear the hedge fund was soliciting loans from any lender who would offer one, and all of these lenders had no idea the others had also capitalized Three Arrows, often with nine-figure loans.
Now research firm FSInsight, an independent research firm, has issued a report making the case Three Arrows was in fact merely an “old-fashioned Madoff-style Ponzi scheme,” where the fund solicited money from whoever would supply it, used the money to service old debt, and delivered phonied paperwork showing outsized returns.
The firm makes the case Kyle Davies, 35, and Su Zhu, 35, the founders of Three Arrows, had “used their reputation to recklessly borrow from just about every institutional lender in the business.”
The note added, Zhu and Davies appear to have been, “using borrowed funds to repay interest on loans issued by lenders, while ‘cooking their books’ to show massive returns on capital.”
The firm likens the operation to a famous hedge fund, Long Term Capital, that was founded by famous Wall Street traders and Nobel Prize-winning economists. The fund collapsed in 1998, so spectacularly it would have taken down the entire market had the government not intervened.
Sean Farrell, head of digital assets at FSInsight notes that while Three Arrows claimed to have $18 billion under management, given the amount of exposure crypto lenders had to the fund, its assets were likely mostly bought with debt, and its collateralization ratio was likely miniscule.
The founders, two former Credit Suisse traders who first became friends in high school, are presently in hiding. In a phone interview with Bloomberg, Zhu said, “People may call us stupid. They may call us stupid or delusional. And, I’ll accept that. Maybe. But they’re gonna, you know, say that I absconded funds during the last period, where I actually put more of my personal money back in. That’s not true.”
Davies said, “The whole situation is regrettable. Many people lost a lot of money.”
Zhu added, “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.”
Zhu then noted the similarities to Long Term Capital, saying, “It was very much like a LTCM moment for us, like a Long Term Capital moment. We had different types of trades that we all thought were good, and other people also had these trades. And then they kind of all got super marked down, super fast.”
The firms which have been given the responsibility to liquidate Three Arrows have recently complained about the two co-founders refusing to cooperate, however the founders have rejected that accusation.
