The ins and outs of Three Arrows Capital’s “bankruptcy”: excessive use of leverage, suspected asset management for investment projects

This is the worst situation I have seen since I entered the cryptocurrency industry. Economic recession, failed risk control, loan problems, bank runs, and VC dumps all rolled into the same quarter.

One of the largest crypto venture capital firms: Three Arrows Capital. They are insolvent, which is catastrophic for crypto with funds under management potentially reaching $18 billion, here is a timeline of what is happening and the possible consequences:

Who is Three Arrows Capital?

We generally call him 3AC, one of the world's largest cryptocurrency-focused venture capital firms. Founders Zhusu and Kyles Ldavies were high school classmates and started in 2012. Originally headquartered in Singapore, they recently moved to Dubai.

Their best investments include:

• Avax

• Near

• Aave

• Derabit

• Starkware

• Terra Luna

• Axie Infinity

They manage an estimated $10-18 billion in assets, and as a top 5 VC firm, they have a profound influence and reputation in the industry.

The influence of speech

Founder Zhusu is also very influential, with 560,000 followers on Twitter. He also often interacts with his followers and uses his influence to indirectly influence prices. For example, he once published an article maliciously slandering ETH, which caused the price of ETH to fall, and then he bought a lot of ETH at a low price. Therefore, whenever Zhusu makes a statement on a social networking site, we don’t know whether he is serious or wants to use his influence to make a profit.

He is also a big supporter of the Supercycle theory. In February 2021, he predicted that the price of BTC would reach $2.5 million on an UpOnly show, and a few weeks ago, he announced that his views on the Supercycle were wrong.

3AC supports Terra Luna. Before Terra collapsed last month, 3AC spent $559.6 million to take over those locked positions of Luna, which is now worth about $670. Some people speculate that the huge loss of Luna caused them to want to use more leverage to get back their profits, which is obviously a subjective "over-trading" brought about by emotions.

The Dangers of Leverage

Charlie Munger once said: "There are three ways to bankrupt a smart man: liquor, ladies, and leverage." This sentence seems to be timeless. In the past few weeks, token prices have plummeted. If the value of your collateral decreases, you are at risk of being liquidated.

What is the liquidity of 3AC?

We know 3AC has made some great investments, but many of the tokens have been locked up for years and lack liquidity. So if they need to make a margin call, they may not have the liquidity available and it will be difficult to repay the loan.

The first signs of bankruptcy

Degen trading claimed that 3AC had borrowed money from every major lender and that many of their positions were at risk of being liquidated.

Some rumors began to circulate that 3AC was about to liquidate its $264 million ETH position. However, Nansen confirmed that the wallet was not marked as 3AC, and apparently, there was a bug in the UI that caused the poster to identify it as 3AC.

Now people are confused again. Is there something wrong with 3AC, or are people spreading FUD about the company? Fortunately, Zhu wrote a tweet about cryptocurrency a few days ago, suggesting that there is something wrong with 3AC.

The price of stETH has been a bit unstable, everyone thought it was Celsius selling their stETH, but now it looks like 3AC is doing the selling.

Truth will come to light sooner or later, Danny works closely with 3AC. They noticed that $1 million was missing from their account. It was clear that the founders were playing dirty and 3AC was being liquidated. Miles suggested keeping an eye on the unlocking. If 3AC had financial problems, then you can assume that they would sell their tokens at the first opportunity.

Further consequences

Unfortunately, we don’t have a complete picture of 3AC’s wallets and positions, and we don’t know how much damage would be incurred if they went bankrupt. Due to the AUM (Assets Under Management), the chain reaction would be catastrophic.

VC is not God, people are biased by the halo effect of VC, many people think Terra is too big to fail, people think companies like Jump and 3AC will help them/solve their problems. But that didn't happen, they are not always right.

Managing Risk

3AC invested in the seed rounds of some of the most famous crypto projects. However, it is now on the verge of bankruptcy. Risk management is greatly underestimated. Remember:

1. Don’t fight the Fed

2. Leverage is dangerous

Summary of key points:

• 3AC lost a lot of liquidity in Terra Luna

• 3AC received margin call and was liquidated

• This could have serious knock-on effects for the industry

• Without solid risk management, it won’t help if your performance grows 100 times

Other Messages

One of 3AC’s portfolio companies emailed me, wishing to remain anonymous while they consider their legal options:

1. It has been confirmed that 3AC led their seed round

2. I’m talking to the founder

3AC invests in various seed rounds of numerous companies, and protocol fundraising is usually in USDC/USDT, so their treasury is usually of little use. Therefore, a common transaction 3AC makes with protocols is to "manage" their treasury.

3AC offers an 8% APR for this, so projects deposit their raised funds from 3AC and other funds from their treasury here. Projects feel safe because... it's 3AC.

Note: Terra researcher FatMan tweeted that according to verifiable sources, Three Arrows Capital had borrowed money from multiple funds and counterparties, and put it into Anchor to generate income without the knowledge of most lenders. Before LUNA fell sharply, Three Arrows Capital held at least hundreds of millions of UST. At the same time, Three Arrows Capital previously held some USDD, and the slight decoupling of USDD some time ago may be related to its selling; in addition, Three Arrows Capital also owed a large debt to BitMEX.

This project X mentioned that liquidation is real and they have spoken to two other projects who also mentioned that they were also deceived by 3AC, which now holds some of their funds, but they don't know what their cash position is.

Me: “Can’t you track your funds on-chain?”

Project Party: “They mixed these funds with a lot of investments and other things, and it is difficult for us to track them.”

So we are now faced with a situation where the money raised by the project parties and their treasury may be gone... I have also confirmed with another agreement that 3AC provides financial management services.

I don't mean to add fuel to the fire by any means, but we need to sort out this crazy situation. Then, we can start rebuilding.