The Crypto Geniuses Who Vaporized a Trillion Dollars
By the spring of 2021, GBTC had fallen below the value of its bitcoins, and Three Arrows was now losing on what was likely its biggest trade. Still, crypto enjoyed a bull run that lasted into April, with bitcoin hitting a record above $60,000 and dogecoin, a cryptocurrency started as a joke, rocketing off on an irrational Elon Musk–boosted rally. Zhu was bullish on dogecoin too. Reports put 3AC’s assets at some $10 billion at the time, citing Nansen (though Nansen’s CEO now clarifies that much of the sum was likely borrowed).
In retrospect, Three Arrows seems to have suffered a fateful loss later that summer — if of the human variety, rather than the financial one. In August, two of the fund’s minority partners, who were based in Hong Kong and routinely worked between 80 and 100 hours a week managing much of 3AC’s operations, simultaneously retired. That left the bulk of their work to Davies, Three Arrows’ chief risk officer, who seemed to take a more laid-back approach to looking out for the firm’s downside. “I think their risk management was a lot better before,” says the former friend.
Around that time, there were signs that Three Arrows was hitting a cash crunch. When lenders asked for collateral for the fund’s margin trades, it often came back pledging its equity in Deribit — a private company — instead of an easily salable asset like bitcoin. Such illiquid assets aren’t ideal collateral. But there was another snag: Three Arrows owned the Deribit stake with other investors, who refused to sign off on using their shares as collateral. 3AC, apparently, was attempting to pledge assets it didn’t have the rights to — and was trying to do so repeatedly, offering the same shares to various institutions, particularly after bitcoin started falling in late 2021. The firm seems to have promised the same chunk of locked-up GBTC to several lenders as well. “We suspect that Three Arrows attempted to pledge some pieces of collateral to many people at once,” says Bankman-Fried, the CEO of FTX. “I would be pretty surprised if that was the entire extent of misrepresentations here; that would be a pretty weird coincidence. I strongly suspect that they made more.”
Bear markets in crypto tend to make any stock-market action look like child’s play. The crashes are so severe that insiders call it “crypto winter,” and the season can last years. That’s where Three Arrows Capital found itself by the middle of January 2022, and it was poorly equipped to weather it. The GBTC position ate an ever-larger hole in 3AC’s balance sheet, and much of its capital was tied up in restricted shares in smaller crypto projects. Other arbitrage opportunities had dried up. In response, Three Arrows seems to have decided to ramp up the riskiness of its investments in hopes of scoring big and getting the firm back on a solid footing. “What made them change was just overreaching for returns,” says a major lending executive. “They were probably like, ‘What if we just go long?’ ”