3AC’s Bankruptcy Might Signal the Beginning of a New Cycle

On July 2, representatives of Three Arrows Capital (3AC) filed for bankruptcy protection, according to court documents. Voyager Digital announced on July 7 that it had also filed for bankruptcy protection. Facing the unprecedented bear, 3AC became the first giant institutional investor to fall. Apart from the panic caused by the global liquidity crunch, what other factors contributed to the sudden downfall of 3AC?

Internal Concerns

Let’s first take a quick look at the internal reasons behind 3AC’s bankruptcy. Simply put, the institution had been playing a high-leverage game via VC investments. In the early days, Zhu Su made the first pot of gold in the DeFi space. As he held a large amount of BTC and ETH, Zhu Su naturally became one of the first-tier venture capitalists when the new bull market kicked off.

Here is roughly how 3AC invested: It borrowed money in the CeFi market and earned arbitrage profits by adding leverage. The hedge fund had deposited its ETH to Ethereum’s PoS Staking for stake mining through Lido, but the ROI was merely 4%. At the time, many platforms launched stETH stake mining, and 3AC saw fit to engage in circular arbitrage, thereby maximizing its returns. Such moves added extremely high leverage to the market, which foreshadowed its bankruptcy.

In addition, 3AC probably used the borrowed money for UST arbitrage. After all, as long as it borrowed funds at a rate lower than the ROI, 3AC could easily profit even if it stayed inactive. However, the UST depeg led to the total collapse of the Terra ecosystem within just a week, and 3AC suffered a 99.9% loss. Following the Terra meltdown, lenders that include Voyager, Celsius, BlockFi, and Babel Finance panicked and started to withdraw their deposits.

Source: Voyager’s bankruptcy filing

It has also been revealed that 3AC misappropriated the funds of 8 Blocks Capital, a client of its OTC trading arm TPS Capital, to add margins. The news immediately created a crisis of confidence, which pushed 3AC further into the pit.

It has been reported that the NFTs of Starry Night, 3AC’s NFT fund, have been transferred to a new wallet for unknown reasons. Creditors, on the other hand, are seeking to freeze 3AC’s assets. They also asked the court to force the company’s founders to disclose all their assets.

As Zhu Su, the founder of 3AC, was accused of not cooperating with liquidators in bankruptcy proceedings, the New York court approved an emergency hearing for 3AC’s creditors, but Zhu Su’s lawyers previously stated that two 3AC executives have disappeared. That said, if liquidators have fully investigated all the assets of 3AC, the market would face another wave of dumping.

External Challenges

Apart from these internal concerns, the crypto market as a whole is going through an unprecedented bear. Facing the global liquidity crunch, some countries have even gone bankrupt. As a large swath of traditional financial institutions invest in the crypto market, cryptocurrency has become closely correlated with traditional finance, and thus now faces greater impacts from the liquidity crunch.

Moreover, there are also “time bombs” such as circular lending behind the prosperity of the DeFi market. In addition, many DeFi projects delivered high returns yet only maintained a small reserve, which contributed to their drastic decline during the present bear market.

For 3AC, the bad news was that Ethereum started to merge into PoS when the disaster hit because users cannot withdraw their stETH before the Merge is completed. As such, 3AC could not sell its crypto holdings in time to add margins, which led to more forced liquidation.

A New Beginning

We sigh at 3AC’s fall. At its peak, the institution managed assets worth nearly $18 billion. Today, both founders and executives have disappeared, and the company has also filed for bankruptcy protection, which marks the downfall of a crypto giant.

That being said, users care more about the impacts of 3AC’s bankruptcy, rather than the fall of the company. The continuous liquidation of 3AC seems to have punched a hole, from which massive funds fled away. This is undoubtedly a major blow to the crypto market, which is going through a global liquidity crisis.

The crisis has also presented opportunities: After the 3AC crisis, plenty of idle crypto assets were withdrawn withdrew their funds, and those who stayed are mostly big investors fully aware of the risks and confident in the long-term prospect of cryptocurrency. That will come as good news to the market.

Furthermore, after the declines, the leverage risks of cryptocurrency are being mitigated, and the market is also gradually absorbing the relevant impacts, which might signal a new market cycle. As we mentioned in previous articles, some institutional investors have already been pumping money into the market. Though these investors might have different goals, they must agree that the bear market is about to end. A final reminder: Keep track of the flow of capital as it brings prosperity to the market.