Crypto hedge fund Three Arrows fails to meet lender margin calls

Three Arrows Capital failed to meet demands from lenders to stump up extra funds after its digital currency bets turned sour, tipping the prominent crypto hedge fund into a crisis that comes as a credit crunch grips the industry.

The group’s failure to meet margin calls this past weekend makes the group the latest victim of an acute fall in the prices of many tokens like bitcoin and ether that is rippling across the market. Singapore-based Three Arrows is among the biggest and most active players in the crypto industry with investments across lending and trading platforms.

Lenders have sharply tightened up how much credit is on offer following tremors over the past month. Celsius, a major crypto financial services company, blocked withdrawals last week, while a pair of major tokens collapsed in May.

US-based crypto lender BlockFi was among the groups that liquidated at least some of Three Arrows’s positions, meaning it reduced its exposure by taking collateral the fund had put down to back its borrowing, according to people familiar with the matter.

Three Arrows, which made a “strategic” investment in BlockFi in 2020, had borrowed bitcoin from the lender, the people said, but had been unable to meet a margin call. One of the people said the liquidation had occurred by mutual consent.

“We are in the process of communicating with relevant parties and fully committed to working this out,” said Su Zhu, Three Arrows co-founder, on Twitter on Wednesday, without specifically identifying any counterparty. The company did not respond to a request for comment.

Yuri Mushkin, BlockFi’s chief risk officer, said the group “can confirm that we exercised our best business judgment recently with a large client that failed to meet its obligations . . . We believe we were one of the first to take action with this counterparty.”

He added that BlockFi had held collateral in excess of the size of the loan.

“BlockFi’s prudent and proactive risk management is for the benefit of our broader client base and allows us to remain open for business during times of market stress,” Mushkin said.

The troubles at Three Arrows ricocheted to Finblox, a platform that offers traders 90 per cent annualised yields to lend out their crypto. Finblox, which is backed by venture capitalist firm Sequoia Capital and received an investment from Three Arrows, reduced its withdrawal limits by two-thirds late on Thursday London time, citing the situation at the hedge fund.

Three Arrows, run by Zhu and his co-founder Kyle Davies, is known for its bullish levered bets on crypto. Zhu had espoused a “supercycle” view of crypto, in which increasing mainstream adoption meant prices would continue rise without falling back into a near-term bear market.

Last month, he acknowledged the current sell-off had proved him wrong. “Supercycle price thesis was regrettably wrong, but crypto will still thrive and change the world every day,” Zhu tweeted in late May.

“They were really big and really active. They went into some enormous positions,” said David Siemer, chief executive of Wave Financial, a digital asset manager. He added that major crypto firms across the space likely had exposure to Three Arrows: “They worked with everybody.”

Three Arrows was mainly, if not exclusively, managing Zhu and Davies’ own capital, according to industry sources. One person who has spoken with the managers in recent months said they were told the fund’s total value was $4bn. Blockchain analytics firm Nansen has previously estimated the funds assets at $10bn.

Another person, who works at a crypto trading firm, said they had been unable to reach Three Arrows in recent days. “They’re not responding to anyone,” they said.

Among Three Arrows’s big bets was luna, the sister token to the algorithmic stablecoin terra. Both imploded in May, going to zero, a market shattering event that turned what had been months of steady declines in crypto prices into a more dramatic rout.

The fund had holdings in a variety of crypto ventures whose tokens have performed badly in recent months, including Avalanche, Solana and the game Axie Infinity, all of which are down around 90 per cent since their November peaks.

Three Arrows was also the biggest investor in units of the Grayscale bitcoin trust, GBTC, according to FactSet data. GBTC currently trades at a 30 per cent discount to the price of bitcoin as the US Securities and Exchange Commission has thus far declined to approve it as an exchange-traded fund that would be open to retail investors.

Until early 2021, GBTC had traded at a premium to the price of bitcoin. That offered an arbitrage opportunity for funds like Three Arrows which could borrow bitcoin, deposit it with Grayscale in return for GBTC units, which could then be sold at a profit on the open market. Grayscale does not allow redemptions of GBTC for the underlying bitcoin.

Three Arrows owned almost 39mn units of GBTC at the end of 2020 then worth $1.2bn, according to its last report to the SEC in January 2021. The same position today would be valued at just $550mn.

Michael Sonnenshein, chief executive of Grayscale, said he had no knowledge of Three Arrows’ trades, but added: “There are players here that have employed too much leverage . . . a major correction in prices is sending shockwaves through the ecosystem”.