3AC was one of the biggest crypto investment funds with billions under management. Yet it got liquidated after losing an enormous amount of money in the Terra disaster – and dragged other crypto companies with it. Here’s what you need to know about Three Arrows Capital, its founders Zhu Su and Kyle Davies, and why this huge fund failed.
When it was revealed on June 29 that 3AC, one of the largest crypto investment funds, entered liquidation, many saw this as yet another sign of impending doom for the market. Yet others were almost glad, as 3AC and its executives Zhu Su and Kyle Davies have a very controversial reputation.
But most of all, the collapse of 3AC, or Three Arrows Capital, was proof of how dangerously interconnected things are in crypto. The downfall of Terra started the chain reaction, and the projects that had exposure to Terra’s $LUNA and $UST were suddenly at risk. We’ve already covered the bankruptcy of the leading crypto lender Celsius.3AC was the next domino to fall, and others could follow.
3AC is far less known to the general public than Terra or Celsius, but it’s a major player in the blockchain industry that commanded over $10 billion in assets at its peak. Moreover, its CEO Zhu Su was one of the most authoritative people on crypto Twitter. So it’s important to understand what 3AC does, how it arrived at liquidation, and what it can mean for the crypto space.
Three Arrows Capital, or 3AC, is a crypto hedge fund based (at least until recently) in Singapore and incorporated in the British Virgin Islands. At its height, it controlled over $10 billion in assets and invested in some of the biggest projects in the space, including Solana and Terra.
The co-founders of 3AC Zhu Su (or Su Zhu – Zhu being his surname) and Kyle Davies are both 35 years old and have known each other since high school. They both graduated from Columbia University in New York and worked as traders for Credit Suisse in Hong Kong.
In 2012, Zhu and Davies started Three Arrows Capital – apparently on the kitchen table in their flat. At first, 3AC was a Forex trading firm focused on emerging markets. By 2015, the young hedge fund had a team of 24 people and controlled between 5% and 10% of the Forex trading volume in its target regions.
However, faced with competition from bigger firms, 3AC started expanding into crypto and stocks and eventually fully switched to crypto in 2018. By early 2021, the company became the largest shareholder in Grayscale Bitcoin Trust, the world’s largest BTC investment product for the traditional stock market.
Three Arrows Capital didn’t just hold cryptocurrencies: it opened large long and short leveraged positions on crypto exchanges. Leverage trading means borrowing funds from the exchange to open a larger trade than one would be able to using just their own capital. For example, using 10x leverage means that a trader uses 1x of their own funds (like $100) and 9x of borrowed funds ($900) for a total position of $1000.
Leverage (or margin) trading is risky, because even a small change in price can produce significant losses and lead to liquidation, when the trader loses all the money invested in a trade. We’ll see later in the article how 3AC got liquidated on a number of long positions.
Zhu Su was always very bullish on Bitcoin long-term – in fact, he may be the originator of the term ‘super cycle’. This theory claims that instead of going through a market cycle of around 4 years ending in a bear market, Bitcoin would do a much longer bullish super cycle that could see it grow to $1 million or even higher.
Zhu Su first explained his super cycle thesis on the Blockfolio YouTube show in February 2021, as BTC was about to embark on a run to $60k. Rewatching it now brings mixed emotions, but back then the audience was very excited about Zhu’s comments.
In 2021, Zhu and Davies also became highly bullish on Ethereum, expecting it to outperform Bitcoin during the ‘supercycle'. 3AC accumulated huge positions in ETH and then in staked ETH (stETH) on platforms like Lido Finance – something we’ll come back to later.
We should also touch upon Zhu Su’s reputation as a Twitter guru. Taciturn in his interviews and cryptic in his tweets, he appeared to know things about the market that others didn’t.
Zhu Su often tweeted about what crypto projects and investors should or shouldn’t do. Ironically, 3AC later committed many of the same mistakes that he used to warn others about – such as ignoring risk management.
In addition to crypto trading, Three Arrows Capital acted as a blockchain investment fund. Before the crash, it was one of the biggest players in crypto investments, together with a16z (Andreessen Horowitz), Alameda Research, Jump Crypto, Binance Labs, and others.
3AC’s portfolio looks like a ‘who’s who’ of crypto: Solana, Polkadot, Kusama, Terra, Aave, dYdX, Balancer, Axie Infinity, WOO Network, BlockFi, Deribit… In the past 12 months alone, 3AC led a $150-million investment round for NEAR and a $230-million round for Avalanche.
Three Arrows Capital didn’t publicly disclose the value of its holdings. However, according to some reports, the fund came to control $18 billion in assets at some point. Other sources, including CoinDesk, state that 3AC managed $3 billion of its clients’ funds in April 2022.
Many of 3AC’s investments did extremely well between the ‘DeFi summer’ of 2020 and the end of 2021, especially Solana, Avalanche, Axie Infinity, and Terra. As their token prices skyrocketed, so did the value of Three Arrows’ holdings. It’s not known at which point 3AC sold their stakes in these projects, but if they did, they could have booked hundreds of millions in profits.
However, 3AC also had a lot of exposure to $LUNA. Back in February, Three Arrows bought $200 million worth of $LUNA from Luna Foundation Guard, which was creating a Bitcoin reserve to prop up $UST (as we’ve explained in our detailed article on Terra). Also, the company’s huge holdings in the Grayscale Bitcoin Trust have suffered enormously.
That’s not all, though: a prominent member of the Terra community known as FatMan tweeted on June 14 that 3AC had also bought 10.9 million staked $LUNA worth over $550 million at the time.
Together with the investment in LFG, that’s over $750 million that turned to dust as $LUNA precipitated from $100+ to less than $0.01. Indeed, speaking to the Wall Street Journal (WSJ), Kyle Davies admitted to the Wall Street Journal that the fund had been ‘caught off guard’ by the collapse of Terra, so we can assume that all that money had been lost.
Kyle Davies even told the WSJ that the firm was considering selling some of its venture stakes in crypto startups.
The WSJ report came out on June 17. But a day before that, another prominent crypto player had already provided proof that 3AC was in dire straits: Danny Yuan, CEO of 8 Blocks.
8 Blocks Capital is a market maker – a trading firm that opens both buy and sell positions for a specific currency pair to make sure that all buyers and sellers can have their orders filled. Market makers make a profit on spreads (the difference between the buy and sell price) and charge a fee to the cryptocurrency projects that use their services.
In turn, 8 Blocks paid Three Arrows Capital to be able to deposit funds in their exchange accounts and use them for trading, which helped them save on exchange fees. The market maker could withdraw the money from the exchange any time and keep all the profit resulting from the trades.
On June 12, 8 Blocks requested a partial refund, and it was processed without problems. However, another withdrawal request on June 13 went unanswered – and on June 16 CEO Danny Yuan tweeted that 8 Blocks had noticed that $1 million of their money was missing from 3AC’s account. 8 Blocks called Kyle Davies, the support team, and everyone else they knew at Three Arrows – but nobody responded. 3AC were ‘ghosting’ them.
Ironically, on June 15 Zhu Su posted a now-infamous tweet claiming that 3AC was ‘fully committed to working this out’.
The ‘working out’ wasn’t going so well, apparently. From talking to other blockchain companies that were involved with 3AC, 8 Blocks found out that Zhu Su’s fund was ghosting them, too. The reason soon became clear: Three Arrows Capital was being margin called.
When a trader uses leverage (that is, funds borrowed from the exchange) and the price moves against them, their position goes deeper and deeper in the red – and eventually they receive a margin call. This is a notification from the exchange that the trader needs to either add funds to the position or face liquidation.
As the price of BTC dropped from $28,000 on June 12 to $21,000 on June 14, it seems that 3AC faced margin calls on their long positions. And as they apparently didn’t have enough cash of their own to add to the margin, they started using their partners’ money – including the $1 million belonging to 8 Blocks.
According to Danny Yuan, 3AC did get liquidated on some of their positions, and this caused the market price to drop further, as the positions were large. Essentially Three Arrows was losing not only their own money, but also that of their clients.
As reported by The Block, three exchanges margin-called and then liquidated 3AC positions by June 17: BitMex, FTX, and Deribit. Three Arrows’ debt to BitMex was the largest: $6 million, according to a source.
On the same day when 8 Blocks’ Danny Yuan posted his Twitter thread, another firm took action against 3AC: BlockFi, a major crypto lending service. On June 16, CEO Zach Prince tweeted that the firm had liquidated ‘a large client’ (which everyone understood to be 3AC) that couldn’t repay an overcollateralized loan.
‘Overcollateralized’ means that the value of the collateral was higher than the borrowed amount, so BlockFi apparently managed to sell the collateral and avoid further losses. Prince stressed that BlockFi was among the first to recover money from the unnamed ‘counterparty’ – which basically made the task more difficult for others to whom Three Arrows owed money.
In total, 3AC is said to have been liquidated for $400 million by various lenders. The final blow came from Voyager Digital, a US-based crypto trading platform. Turns out, 3AChad borrowed $350m in USDC and over 15,000BTC (worth about $30 million) but failed to repay the loan by June 27 as required.
In response, Voyager announced that it would issue a notice of default – a formal notice filed with the court to inform that a debtor has defaulted. This usually precedes court action.
On June 27, 2022, a court in the British Virgin Islands (BVI) issued a liquidation order for 3AC, as reported by Sky News. This time it wasn’t about liquidating a leveraged position, though, but rather liquidating the whole company. Three Arrows was to be declared insolvent, and its assets would be sold off to pay back the creditors. A firm called Teneo Restructuring would oversee the insolvency procedure in the BVI, where 3AC is registered.
The assets to be liquidated include 3AC’s startup investments, any cryptocurrency it still holds, and its considerable NFT portfolio. A prominent analyst called Alex Svanevik has published a full list of the NFT portfolio on Twitter, and the commenters calculated that its value is below 200 ETH ($220k).
As the problems piled up, Zhu Su apparently also started selling off his personal assets. He is rumored to have put a $35m bungalow in Singapore up for urgent sale. Why such haste? Perhaps because at this point Zhu was already planning to flee the country.
On July 1, Three Arrows Capital filed for Chapter 15 bankruptcy in the US. In theory, this move would protect 3AC’s assets in the United States from the liquidation carried out in the British Virgin Islands. The law firm representing 3AC is called Latham and Watkins.
When the representatives of Teneo Restructuring went to visit 3AC’s office in Singapore, they found it empty, with unopened mail under the door. And while Zhu and Davies were apparently present on a Zoom call with their lawyers and liquidators on July 8, their audio and video were turned off, so that the lawyers did all the talking.
The liquidators were worried that Zhu and Davies could be selling off their remaining crypto (in addition to houses and who knows what else). Finally, on July 12, the court granted Teneo the right to dispose of any of 3AC’s assets that remain within the jurisdiction of the United States.
At the same time, the judge acknowledged that it would be ‘tricky’ for the liquidators to take control of the fund’s crypto wallets – as nobody has the private keys for them.
Teneo was also granted a subpoena – the right to compel Zhu and Davies to appear in court. The liquidators can also subpoena the representatives of crypto exchanges and banks that were involved with 3AC, which could provide some information on the location of the assets.
On July 12, Zhu Su appeared on Twitter for the first time since June 15 (remember the 'We’re fully committed to working this out' message?). He wrote that the liquidators had ‘baited’ him, tricking 3AC into discussing the sale of certain StarkWare tokens– then using the information they received in court.
As of the time of writing, this is where things stand: Kyle Davies and Zhu Su are nowhere to be found, not cooperating with the liquidators, and maybe even selling whatever crypto they still have. Three Arrows Capital went from several billion under management to virtually zero in a few weeks. Its creditors and other crypto companies involved with 3AC lost hundreds of millions of dollars that aren’t likely to be recovered.
Major crypto exchanges and lenders weren’t the only ones to have suffered from the downfall of Three Arrows Capital. Here are a few other projects that suffered alongside 3AC.
Lido is a liquid staking platform where you can stake ETH and other cryptocurrencies to receive yield – but at the same time get special staked-assets (like stETH)to use in other DeFi products and generate additional returns. Lido had already lost $10 billion in TVL because of the Terra debacle, as $LUNA staking was its most popular product – but it was about to lose more as 3AC and another embattled platform, Celsius, were forced to sell off their stETH to cover up the loans and losses elsewhere.
In theory, 1 stETH should trade for 1 ETH, but in the case of strong sell pressure this peg, was lost.
In total, Three Arrows sold over 49,000 stETH (over $50 million at current prices), and as a result, the price of stETH dropped to 0.93 ETH. You can also see a further drop in Lido’s TVL from $7.6b to $4.7b between June 9 and June 18.
In a screenshot published by the crypto Twitter analyst The DeFi Edge, an unnamed protocol confirmed that 3AC offered them treasury management services.
The scheme ran as follows: Three Arrows would invest in a startup, then offer to securely invest the startup’s capital at 8% APY. It means that 3AC gave startups money, then took the same money back, and reinvested it in risky trades. If true, these ‘treasuries’ could now also be gone.
Finblox, a platform where users could earn high yields on their crypto which counted 3AC as an investor, paused all reward distributions on June 16. It also disabled the creation of new accounts and introduced daily withdrawal limits
Voyager Digital, which couldn’t collect the $380m loan from 3AC, was forced to halt trading, deposits, and loyalty reward payouts on July 1. Voyager had to be rescued by Alameda (a major crypto fund belonging to FTX CEO Sam Bankman-Fried) which extended Voyager a loan of around $300m in USDC and BTC.
Perhaps nobody has summarized the situation better than former BitMex CEO Arthur Hayes in his excellent blog. (Hayes himself has just been sentenced to two years’ probation for a violation of bank secrecy rules, but this doesn’t detract from the value of his blog posts.) He points out that Zhu Su and Kyle Davies made their names and money on arbitrage – exploiting small price differences in inefficient traditional markets.
In crypto, their arbitrage strategy also worked, but they saw that the returns would be much higher if they got into directional trading (being net long or short) or trading with borrowed funds. 3AC used both these instruments – and what did them in was their being net long on $LUNA and borrowing USD to buy UST stablecoins and park them on the Anchor protocol at a 20% APY.
Arthur Hayes writes that 3AC probably borrowed billions of dollars to build their $UST position that paid 20% a year. When $LUNA and $UST both collapsed, all that money was gone – and 3AC couldn’t repay the loans.
Ultimately it all goes back to Terra and its founder Do Kwon. If it were not for his hubris and refusal to take the risks to $LUNA seriously, the meltdowns of Celsius and 3AC might not have happened.
But we shouldn’t discount Three Arrows’ ‘aura of invincibility’ that Arthur Hayes mentions, either. It was because of this aura that everyone was so eager to lend 3AC money without considering the risks. This blind trust in the reputations of large crypto projects and their founders (be it Zhu Su, Do Kwon, etc.) is another huge risk for the space.
Finally, we should note that 3AC, Celsius, and Voyager are all centralized projects. No decentralized lending protocols collapsed as a result of the 3AC liquidation. This is yet another indicator that true DeFi could be the way forward towards a more secure crypto industry.
That’s why we at Pontem Network are betting on decentralized, non-custodial services – and not CeFi projects that dabble in crypto. We believe in DeFi built on safer blockchains – primarily Aptos with its extremely secure Move language.
We’ve already released a wallet, the first Aptos-based DEX LiquidSwap, and the browser code editor Move Playground. Many more are coming - follow us on Twitter and Telegram for more updates both on our Aptos dApps and on the next events in the sad saga of Terra, Celsius, and Three Arrows Capital.