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From $10 billion to zero: How a crypto hedge fund collapsed and dragged many investors down with it


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https://www.cnbc.com/2022/07/11/how-the-fall-of-three-arrows-or-3ac-dragged-down-crypto-investors.html

 

From $10 billion to zero: How a crypto hedge fund collapsed and dragged many investors down with it
Published Mon, Jul 11 20223:30 PM EDTUpdated Mon, Jul 11 20224:25 PM EDT, MacKenzie Sigalos @KENZIESIGALOS

 

Key Points

 

- The bankruptcy filing from Three Arrows Capital (3AC) triggered a downward spiral that wrapped in many crypto investors.

 

- The hedge fund failed to meet margin calls from its lenders.

 

- “3AC was supposed to be the adult in the room,” said Nik Bhatia, professor of finance and business economics at the University of Southern California.

 

As recently as March, Three Arrows Capital managed about $10 billion in assets, making it one of the most prominent crypto hedge funds in the world.

 

Now the firm, also known as 3AC, is headed to bankruptcy court after the plunge in cryptocurrency prices and a particularly risky trading strategy combined to wipe out its assets and leave it unable to repay lenders.

 

The chain of pain may just be beginning. 3AC had a lengthy list of counterparties, or companies that had their money wrapped up in the firm’s ability to at least stay afloat. With the crypto market down by more than $1 trillion since April, led by the slide in bitcoin and ethereum, investors with concentrated bets on firms like 3AC are suffering the consequences.

 

Crypto exchange Blockchain.com reportedly faces a $270 million hit on loans to 3AC. Meanwhile, digital asset brokerage Voyager Digital filed for Chapter 11 bankruptcy protection after 3AC couldn’t pay back the roughly $670 million it had borrowed from the company. U.S.-based crypto lenders Genesis and BlockFi, crypto derivatives platform BitMEX and crypto exchange FTX are also being hit with losses.

 

“Credit is being destroyed and withdrawn, underwriting standards are being tightened, solvency is being tested, so everyone is withdrawing liquidity from crypto lenders,” said Nic Carter, a partner at Castle Island Ventures, which focuses on blockchain investments.

 

Three Arrows’ strategy involved borrowing money from across the industry and then turning around and investing that capital in other, often nascent, crypto projects. The firm had been around for a decade, which helped give founders Zhu Su and Kyle Davies a measure of credibility in an industry populated by newbies. Zhu also co-hosted a popular podcast on crypto.

 

“3AC was supposed to be the adult in the room,” said Nik Bhatia, a professor of finance and business economics at the University of Southern California.

 

Court documents reviewed by CNBC show that lawyers representing 3AC’s creditors claim that Zhu and Davies have not yet begun to cooperate with them “in any meaningful manner.” The filing also alleges that the liquidation process hasn’t started, meaning there’s no cash to pay back the company’s lenders.

 

Zhu and Davies didn’t immediately respond to requests for comment.

 

Tracing the falling dominoes

 

The fall of Three Arrows Capital can be traced to the collapse in May of terraUSD (UST), which had been one of the most popular U.S. dollar-pegged stablecoin projects.

 

The stability of UST relied on a complex set of code, with very little hard cash to back up the arrangement, despite the promise that it would keep its value regardless of the volatility in the broader crypto market. Investors were incentivized — on an accompanying lending platform called Anchor — with 20% annual yield on their UST holdings, a rate many analysts said was unsustainable.

 

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The flowchart shows the crypto firms affected by the implosion of TerraUSD and 3 Arrows Capital's bankruptcy filing.

 

“The risk asset correction coupled with less liquidity have exposed projects that promised high unsustainable APRs, resulting in their collapse, such as UST,” said Alkesh Shah, global crypto and digital asset strategist at Bank of America.

 

Panic selling associated with the fall of UST, and its sister token luna, cost investors $60 billion.

 

“The terraUSD and luna collapse is ground zero,” said USC’s Bhatia, who published a book last year on digital currencies titled “Layered Money.” He described the meltdown as the first domino to fall in a “long, nightmarish chain of leverage and fraud.”

 

3AC told the Wall Street Journal it had invested $200 million in luna. Other industry reports said the fund’s exposure was around $560 million. Whatever the loss, that investment was rendered virtually worthless when the stablecoin project failed.

 

UST’s implosion rocked confidence in the sector and accelerated the slide in cryptocurrencies already underway as part of a broader pullback from risk.

 

3AC’s lenders asked for some of their cash back in a flood of margin calls, but the money wasn’t there. Many of the firm’s counterparties were, in turn, unable to meet demands from their investors, including retail holders who had been promised annual returns of 20%.

 

“Not only were they not hedging anything, but they also evaporated billions in creditors’ funds,” said Bhatia.

 

Peter Smith, the CEO of Blockchain.com said last week, in a letter to shareholders viewed by CoinDesk, that his company’s exchange “remains liquid, solvent and our customers will not be impacted.” But investors have heard that kind of sentiment before — Voyager said the same thing days before it filed for bankruptcy.

 

Bhatia said the cascade hits any player in the market with significant exposure to a deteriorating asset and liquidity crunch. And crypto comes with so few consumer protections that retail investors have no idea what, if anything, they’ll end up owning.

 

Customers of Voyager Digital recently received an email indicating that it would be a while before they could access the crypto held in their accounts. CEO Stephen Ehrlich said on Twitter that after the company goes through bankruptcy proceedings, customers with crypto in their account would potentially receive a sort of grab bag of stuff.

 

That could include a combination of the crypto they held, common shares in the reorganized Voyager, Voyager tokens and whatever proceeds they’re able to get from 3AC. Voyager investors told CNBC they don’t see much reason for optimism.

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https://asia.nikkei.com/Spotlight/Cryptocurrencies/Singapore-set-to-get-tougher-on-crypto-companies?utm_campaign=GL_asia_daily&utm_medium=email&utm_source=NA_newsletter&utm_content=article_link&del_type=1&pub_date=20220719190000&seq_num=8&si=44594

 

Singapore set to get tougher on crypto companies
Monetary Authority puts industry on notice about tightening rules

 

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Singapore's central bank on July 19 reported a loss of 4.7 billion Singapore dollars ($3.37 billion) as the strong dollar undermined the value of other currencies in its portfolio.   © Reuters DYLAN LOH, Nikkei staff writerJuly 19, 2022 16:24 JST

 

SINGAPORE -- Singapore is set to get tougher on cryptocurrency companies in the coming months, as the central bank plans to start talking with industry players by September or October with a view to drawing up tighter regulations for the emerging sector.

 

The Monetary Authority of Singapore's Managing Director Ravi Menon signaled this on Tuesday with the release of the financial regulator's annual report, saying the process of consultation in the coming months will touch on broadening the scope of its rules to cover more activities in the industry.

 

"So, players who are doing some of these activities but are currently not caught, may well be caught," he told journalists. "When we put out the consult, when we say what are the additional areas that we will regulate, it will capture a wider ambit of players."

 

Menon noted that cryptocurrency companies with a presence in Singapore have been under strain, naming TerraForm Labs and Three Arrows Capital as outfits that are either not licensed or have not come under the city-state's rules applicable to digital token service providers.

 

Led by prominent crypto evangelists, the co-founders of Terra, Do Kwon, and Three Arrows' Su Zhu and Kyle Davies, are high-profile casualties of recent plunges in token prices that have set off a crisis in the industry.

 

Investors and creditors blame them for massive investment losses that appear unrecoverable, with some going as far as to accuse the entrepreneurs of defrauding clients.

 

Singapore regulates the crypto sector primarily for money laundering and terrorism financing risks, but it has taken a largely hands-off approach when it comes to setting rules on crypto assets as investments. The Monetary Authority has, however, asked crypto companies to stop mass marketing activities and warned repeatedly of the pitfalls of digital tokens as financial assets.

 

The central bank is set to go further, planning to draw up rules governing retail participation in crypto activities. "We want to take this targeted approach, and that's why we want to explain our overall approach to the industry," Menon said Tuesday. "It's a targeted effort to contain the risk and overexposure of retail investments in cryptocurrencies."

 

Beyond the crypto sector, Singapore's central bank on Tuesday also reported a loss of 4.7 billion Singapore dollars ($3.37 billion) on its official foreign reserves balance sheet, as the strong dollar undermined the value of other currencies, amid gloomy global conditions that have sparked a rush for safe-haven assets.

 

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Ravi Menon, managing director of the Monetary Authority of Singapore, speaks at a news conference in Singapore on July 19. (Photo by Dylan Loh)

 

The Monetary Authority logged the rare loss in its investments for the financial year ended March 31, its first decline in about a decade, with its most recent previous loss of SG$10.1 billion booked in 2012.

 

It held SG$513.8 billion in official foreign reserves (OFR) as of the end of March. The authority said in its report that its investment portfolio is diversified across advanced and emerging market economies, and across different currencies.

 

While interest income, dividends and realized capital gains helped the central bank book a gain of SG$4 billion, it lost money on its currency conversions equal to a decline of SG$8.7 billion, as the Singapore dollar strengthened significantly against the euro, yen and British pound, the authority highlighted in its report.

 

"Negative [currency conversion] effects have no impact on us at all. It's because we report our profits in Singapore dollars, that's where you have a translation effect," Menon said on Tuesday. "There are some years when we have embarrassingly large profits -- more than 20 billion dollars -- and a good part of it is because of positive ... translation gain."

 

The central bank spreads its holdings across a basket of currencies of Singapore's important trading partners, and the net effect of the weakening of a clutch of those currencies, amid a strong dollar, led to the SG$4.7 billion overall loss.

 

"Investment-grade bonds in the advanced economies form the largest allocation in the portfolio," the financial regulator said in its report. "About three-quarters of the OFR are denominated in U.S. dollars, the euro, Japanese yen and pound sterling, with U.S. dollar forming the bulk."

 

Despite the greenback forming the bulk of its portfolio, as investors flocked to it as a safe-haven asset amid uncertain global economic conditions, it was not enough to overcome the losses Singapore logged from its holdings of other weakening currencies, said Song Seng Wun, an economist at the private banking arm of Malaysian lender CIMB.

 

"Central banks around the world will all get similar hits to their reserves, just as the Singapore central bank has, just from translation losses," he told Nikkei Asia, explaining that the recent strengthening of the dollar has only reinforced the devaluation of other currencies.

 

"This is not structural or mismanagement, this is something almost out of our control," Song added. "So that's the problem of all central banks, which have to deal with the strong U.S. dollar."

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