Su Zhu and Kyle Davies Three Arrows Founders Break Silence Over Collapse of Crypto Hedge Fund


After five weeks in dark, the disgraced founders of Three Arrows Capital spoke at length about the mighty implosion of their once high-flying cryptocurrency hedge fund, saying their bungled Cryptocurrency speculation unleashed pouring margin calls on loans that should never have been done.


Su Zhu and Kyle Davies, both 35, first became friends in high school. They built 3AC into a Cryptocurrency-trading giant before its collapse bankrupted creditors and aggravated a selloff that imposed steep losses on mom-and-pop owners of Bitcoin and other coins. At times apologetic and at times defensive, Davies and Zhu, speaking from an undisclosed location, described a systemic failure of risk management strategy in which easy-flowing credit worsened the influence of wrong-way bets. 


They recognized the collapse triggered widespread discomfort, but mostly talked around questions about the effect on others in the Cryptocurrency Industry. Instead, they stressed they suffered deep losses while denying allegations they pulled money out of 3AC before it all blew up. “People may call us imprudent. They may call us stupid or delusional. And, I will accept that. Maybe,” Zhu said. “But they are gonna, you know, say that I escaped funds during the last period, where I actually put more of my personal money back in. That is not true.”


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Advisers in charge of liquidating the fund said in 8th July filings that Zhu and Davies had not collaborated with them and that the founders locations were unknown. Zhu said death threats had enforced them to go into hiding. “That does not mean that we have not been in touch with all relevant authorities,” said Zhu in the telephone interview with Davies and two lawyers from Solitaire LLP. “We have been in touch with them from day one.”


The two refused to say where they were but one of the lawyers on the call said their ultimate location is the United Arab Emirates, which has emerged as a hub for Digital Currency Industry.


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In an extensive interview, the former Credit Suisse traders explained the events leading to their hedge fund is implosion, which led to a chain reaction that has cost institutional clients and small-time speculators billions of dollars. 


“The whole situation is unfortunate,” Davies said. “Many people lost a lot of money.”


Leveraged Bets Meet Crypto Winter


Creditors of the hedge fund, recently registered in the British Virgin Islands, filed document saying they are owed more than $2.8 billion in unsecured claims. That figure is expected to grow significantly, court documents show. To date, liquidators overseeing the insolvency proceedings have gained control of the company is assets worth at least $40 million.


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Zhu and Davies, long among the most vocal Cryptocurrency bulls in an industry known for extremes, put on trades – turbocharged by leverage – that put Three arrow capital at the middle of a series of implosions that shook the cryptocurrency market as prices slumped this year from their highs last fall. “We positioned ourselves for a kind of crypto market that did not end up happening,” Zhu said. 



“We believed in the whole thing to the fullest,” added Davies. “We had all of our, almost all of our resources in there. And then in the good times we did the best we could. And then in the bad times we lost the most of it.”


At the same time, they claim, their case is not an outlier. They describe a coming together of interrelated one-way bets and cooperative borrowing arrangements that all blew up at once, leading not just to their hedge fund’s demise but to bankruptcy proceedings, distress and bailouts at Cryptocurrency firms like Celsius Network, Voyager Digital and BlockFi.


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“Its not a surprise that Celsius, ourselves, these kinds of organizations, all have problems at the same time,” Zhu said. “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 are in the business of taking in deposits and then generating yield, then that, you know, means we end up doing similar trades.”


Efforts by Zhu and Davies to shift blame are a sharp contrast to the partner is previously persistent campaign of cheer-leading Cryptocurrency Assets and belittling critics. Nerves were scraped anew this week by creditor claims that the founders put a down payment on a $50 million yacht before the hedge fund went under, a claim Zhu said is part of a smear campaign against them.


The boat “was bought over a year ago and specially made to be built and to be used in Europe,” Zhu said, adding the yacht “has a full money trail.” He refused the perception that he enjoyed an extravagant lifestyle, noting that he biked to work and back every day and that his family owns “only has two homes in Singapore.” 


“We were never seen in any extravagant place spending lots of money. We were never seen, you know, kind of driving expensive cars like Ferraris and Lamborghinis around,” Zhu said. “This kind of smearing of us, I feel, is just from a classic playbook of, you know, when this stuff happens, when such hedge funds blow up, then you know, these are kind of the headlines that people like to play.”


The Long Arm of Luna


Davies and Zhu recognized heavy losses related to trades in Terra Luna and the now-obsolete algorithmic stablecoin, TerraUSD, saying they were caught by disbelief at the speed of the downfall of these tokens. 


“What we failed to comprehend was that Luna was capable of deteriorating to effective zero in a matter of days and that this would catalyze a credit squeeze across the Cryptocurrency Industry that would put a significant burden on all of our illiquid positions,” Zhu said.


In recollection, Zhu said, the firm may have been too close to Terra is founder, Do Kwon.


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“We started to know Do Kwon on an individual basis as he moved to Singapore. And we just felt like the venture was going to do very big things, and had already done very big things,” he said in describing the firm’s mistakes. “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.”


“It was very much like a LTCM instance for us, like a Long-Term Capital moment,” Zhu said.  “We had varieties of trades that we all believed were good, and other people also had these trades,” Zhu said. “And then they kind of all got super marked down, super-fast.”


One of those trades involved an Ethereum-linked token called staked ETH, or stETH -- intended to be a tradable proxy for Ether and widely used in decentralized finance (DeFi). While every stETH is meant to be convertible for one Ethereum once long-awaited merge of the Ethereum Blockchain Network take effect, the turmoil started by Terra USD is collapse caused its market price to fall below that level. This, in turn, in Zhu’s telling, instigated other users to put on trades that could benefit from the widening gap.


“Because Luna just happened, it, it was very much a contamination where people were like, OK, are there people who are also leveraged long staked Ether versus Ether who will get liquidated as the market price goes down?” Zhu said. “So, the whole Crypto Industry kind of effectively looked desperately for these positions, thinking that, you know, that because it could be hunted essentially.”


Still, the hedge fund was able to continue borrowing from large Digital Currency and Asset lenders and high net worth investors, until, that is, they blew themselves up.


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After Luna is implosion, Zhu said lenders were “comfortable” with the hedge fund’s financial situation, and that they allowed them to keep trading as “as if nothing was wrong.” As courts papers have now revealed, many of these loans had required only a very small amount of collateral.


“So, I just think that, you know, throughout that period, we continued to do business as usual. But then yeah, after that day, when, you know, Bitcoin went from $30,000 to $20,000, you know, that, that was extremely throbbing for us. And that was in, that ended up being kind of the nail in the coffin.”


Zhu said that “if we were more on our game, we would’ve seen that the crypto credit market itself can be a cycle and that, you know, we may not be able to access additional credit at the time that we need it. If, if its kind of, you know, it hits the fan.”


Locked in to Grayscale Bitcoin Trust


Another bullish trade that came back to bite the hedge fund was through the Grayscale Bitcoin Trust, or GBTC. The closed-end fund lets people who can not or do not want to hold BTC directly to instead buy shares in a fund that invests in them. For a while, GBTC was one of the few US-regulated Cryptocurrency products, so it had the market to itself. It was so prevalent that its shares traded at a constant premium to the value of the Bitcoin it held on the secondary market.


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Grayscale allowed big investors like three arrow capitals to purchase shares directly by giving Bitcoin to the trust. These GBTC investors could then sell the shares to the secondary market. That premium meant any sales could net an attractive profit for the investors. At the time of its last filing at the end of 2020, three arrow capital was the largest holder of GBTC, with a position of then worth $1 billion.


The strategy had a hurdle, though: The shares bought directly from Grayscale were locked up for six months at that time. And starting in early 2021, that restriction became a huge problem. GBTC is price slipped from a premium into a discount—a share was worth less than the Bitcoin backing it—as it faced tougher competition from similar Crypto products. As the days and months went on, the discount got wider and wider and the so-called GBTC arbitrage trade no longer worked – especially hurting depositors that used leverage to try to enhance returns.


In Zhu and Davies telling, it was somewhat their own achievement that aided propel both GBTC and the herd mindset around the trade.


“We managed to do it at the right window when it was a very big profit,” Zhu said. “And then like others copied us into that trade later on and then lost not just the money, but also went into negative. Because everyone did it, then the trust went to discount and then it went to a far bigger discount than anyone thought possible.”


No Risk-Free Returns


In response to queries about what went wrong at the hedge fund firm, Zhu cited presumptuousness born of a multiyear bull market that suffused not just him and Davies but nearly all of the crypto industry is credit infrastructure, where such lenders saw their values swell by virtue of financing firms like his.


“There was always an understanding of what they were getting themselves into, this was a risky firm,” Zhu said. “For us, if you go to our website, we have always had massive disclaimers about cryptocurrency risk. We have never once pitched ourselves as risk-free, like a simple yield.”


When Cryptocurrency Markets first started buckling in May, “we met all margin calls,” he said. “And, and so people understood that there was a risk involved.”


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