Well, well, well ... the founders of the beleaguered Three Arrows Capital (3AC), Su Zhu and Kyle Davies, have finally resurfaced from their 5 week absence. Claiming they were in hiding away from death threats, they now show their faces and speak with a representative of Bloomberg to tell their story.
Su Zhu and Kyle Davies, both 35, first became friends in high school. They built 3AC into a crypto-trading behemoth before its collapse bankrupted creditors and exacerbated a selloff that foisted steep losses on mom-and-pop owners of Bitcoin and other tokens. At times contrite and at times defensive, Davies and Zhu, speaking from an undisclosed location, described a systemic failure of risk management in which easy-flowing credit worsened the impact of wrong-way bets.
[Ossinger, J., Shen, M. and Yang, Y. Three Arrows Founders Break Silence Over Collapse of Crypto Hedge Fund. (Accessed July 22, 2022)].
"... the two co-founders of Three Arrows Capital, [...] have jointly admitted that overconfidence, which came from the humbled bull market, was the reason behind the collapse of the firm" [Odunayo, S. 3AC Founders Reveal Ties to Terra (LUNA) Founder Do Kwon, Say Overconfidence Initiated the Collapse. (Accessed July 22, 2022)]. They both fully admitted that "the overconfidence born out of a multiyear bull market, where lenders saw their value swell by virtue of financing firms like 3AC, led to a series of bad decisions that should have been avoided" [Jha, P. 3AC founders reveal ties to Terra founder, blame overconfidence for collapse. (Accessed July 22, 2022)].
Zhu additionally revealed their closeness to Terra founder Do Kwon and claimed they believed the agency was going to do large issues. He admitted that the agency’s closeness to Terra made them overlook sure crimson flags concerning the agency, which finally led to their $500 million price of funding going to zero.
[Jai Tuss. 3AC founders reveal ties to Terra founder, blame overconfidence for collapse. (Accessed July 22, 2022)].
More specifically with regard to Terra/Kwon:
Davies and Zhu acknowledged heavy losses related to trades in Luna and the now-defunct algorithmic stablecoin TerraUSD, saying they were caught by surprise at the speed of the collapse of these tokens. '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 said. In retrospect, Zhu said, the firm may have been too close to Terra’s founder, Do Kwon.
[Ossinger, et. al., supra]
Additionally:
'We began to know Do Kwon on a personal basis as he moved to Singapore. And we just felt like the project was going to do very big things, and had already done very big things,' he said in describing the firm’s miscalculations. '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 moment for us, like a Long Term Capital moment,' Zhu said. 'We had different types of trades that we all thought were good, and other people also had these trades,' Zhu said. 'And then they kind of all got super marked down, super fast. (emphasis added)
[Id].
"The two founders claimed that the LUNA (now known as Luna Classic) investment surely was a setback for the firm. Still, the real issue began when Bitcoin (BTC) fell below $20,000, and it became impossible for the firm to access additional credit. Zhu claimed that even after LUNA’s collapse, business was as usual... [Jha, supra]. Zhu explained:
'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 painful 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 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 it kind of, you know, it hits the fan.'
[Ossinger, et. al., supra].
And, as well, the 'bullish' Grayscale GBTC trade ultimately came back to haunt 3AC. In this regard:
Grayscale allowed big investors like 3AC to purchase shares directly by giving Bitcoin to the trust. These GBTC holders could then sell the shares to the secondary market. That premium meant any sales could net an attractive profit for the big investors. At the time of its last filing at the end of 2020, 3AC’s was the largest holder of GBTC, with a position then worth $1 billion. The strategy had a snag, though: The shares bought directly from Grayscale were locked up for six months at a time. And starting in early 2021, that restriction became a problem. GBTC’s price slipped from a premium into a discount—a share was worth less than the Bitcoin backing it—as it faced stiffer competition from similar products. As the months went on, the discount got wider and wider and the so-called GBTC arbitrage trade no longer worked – especially hurting investors that used leverage to try to enhance returns.
[Id].
According to Zhu and Davies:
... it was partly their own success that helped propel both GBTC and the herd mentality 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.'
[Id].
And as a side note:
Nerves were raked anew this week by creditor claims that the founders put a down payment on a $50 million yacht before the fund went under, a claim Zhu said is part of a smear campaign. The boat 'was bought over a year ago and commissioned to be built and to be used in Europe,' Zhu said, adding the yacht 'has a full money trail.' He rejected the perception that he enjoyed an extravagant lifestyle, noting that he biked to work and back every day and that his family 'only has two homes in Singapore. We were never seen in any clubs spending lots of money. We were never seen, you know, kind of driving 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 funds blow up, then you know, these are kind of the headlines that people like to play.'
[Id].