The Crypto Geniuses Who Vaporized a Trillion Dollars
While Zhu and Davies grew accustomed to their new wealth, Three Arrows continued to be a giant funnel for borrowed capital. A lending boom had taken hold of the crypto industry, as DeFi (short for “decentralized finance”) projects offered depositors much higher interest rates than they could get at traditional banks. Three Arrows would, through its “borrowing desk,” take custody of cryptocurrency that belonged to employees, friends, and other rich individuals. When lenders asked Three Arrows to put up collateral, it often pushed back. Instead, it offered to pay an interest rate of 10 percent or more, higher than any competitor was delivering. Because of its “gold standard” reputation, as one trader put it, some lenders didn’t ask for audited financial statements or any documents at all. Even large, well-capitalized, professionally run crypto companies were lending large sums of money uncollateralized to 3AC, among them Voyager, which was ultimately pushed into bankruptcy.
For other investors, Three Arrows’ appetite for cash was another warning sign. In early 2021, a fund called Warbler Capital, managed by a 29-year-old Chicago native, was trying to raise $20 million for a strategy that largely involved outsourcing its capital to 3AC. Matt Walsh, a co-founder of crypto-focused Castle Island Ventures, couldn’t understand why a multibillion-dollar fund like Three Arrows would bother with onboarding such a relatively tiny increment of money; it seemed desperate. “I was sitting there scratching my head,” Walsh recalls. “It started to put up some alarm bells. Maybe these guys were insolvent.”
The trouble seems to have started in earnest last year, and Three Arrows’ huge bet on GBTC was the nub of it. Just as the firm reaped the rewards when there was a premium, it felt the pain when GBTC began trading at a discount to bitcoin. GBTC’s premium had been a result of the initial uniqueness of the product — it was a way to own bitcoin in your eTrade account without having to deal with crypto exchanges and esoteric wallets. As more people piled into the trade and new alternatives emerged, that premium disappeared — then went negative. But plenty of smart market participants had seen that coming. “All arbitrages die after a point,” says a trader and former colleague of Zhu’s.
Davies was aware of the risk this posed to Three Arrows, and on a September 2020 episode of a podcast produced by Castle Island, he admitted he expected the trade would fade. But before the show aired, Davies requested that the segment be edited out; the firm obliged. Unwinding the position was somewhat tricky — Three Arrows’ GBTC shares were locked up for six months at a time — but Zhu and Davies had a window to get out sometime that fall. And yet they didn’t.
“They had ample opportunity to get out with a graze but not blow themselves up,” says Fauchier. “I didn’t think they could be stupid enough to be doing this with their own money. I don’t know what possessed them. This was obviously one of those trades you want to be the first one in, and you desperately don’t want to be the last one out.” Colleagues now say Three Arrows hung in its GBTC position because it was betting the SEC would approve GBTC’s long-anticipated conversion to an exchange-traded fund, making it much more liquid and tradable and likely erasing the bitcoin price mismatch. (In June, the SEC rejected GBTC’s application.)