Three Arrows Capital Co-founders Explain Hedge Fund Collapse as Overconfidence

The founders of Three Arrows Capital, Su Zhu and Kyle Davies, in an interview with Bloomberg described overconfidence, bred by years of a bull market, as the primary cause of the collapse of the liquidated hedge fund.

According to them, similar sentiments were characteristic across the entire crypto-lending industry.

For clients, such activity was framed as “risky.” They were aware of this and in May, amid deteriorating market sentiment, when the firm fulfilled the arising margin calls.

Overconfidence gave rise to a “systemic failure in risk management,” they noted.

According to them, a combination of interconnected one-sided bets and adaptive borrowing agreements that “blew up” at once affected not only the fund’s collapse but also caused problems for Celsius Network, Voyager Digital and BlockFi.

“We have our own capital […] we also take deposits from creditors, and then generate yields from them. […] This means that in the end we are making similar trades,” — explained Su Zhu.

The top executives acknowledged that the speed with which Terra collapsed caught them off guard. They conceded that this happened “because of being too close” to the project’s founder Do Kwon.

“We could not realise that LUNA could fall to zero within days. That would lead to a contraction of lending across the industry and put considerable pressure on all our illiquid positions. For us it was very much like a LTCM moment. We, like others, had different kinds of trades we considered ‘good’. And then they all suddenly were negatively valued at once. […] It looked like ‘contagion’,” — they explained.

According to the founders, the hedge fund was able to continue operating because everyone was “content” with its financial position and allowed them to trade “as if nothing happened.”

Another problem for 3AC was the situation with Grayscale Investments’ GBTC. The hedge fund increased its position in the instrument to the equivalent of $1 billion. In the face of the emergence of competing products, the discount of the Bitcoin Trust to NAV expanded, and due to the lockup-period the firm could not exit the leveraged position.

“We continued doing business as usual. But then, when Bitcoin crashed from $30,000 to $20,000, […] it was a kind of nail in the coffin,” — admitted Su Zhu.

The founders did not consider that the credit market might be cyclical. They suggested it became possible “due to being too close” to a founder Do Kwon.

In response to the speculation about asset withdrawals against 3AC shortly before its collapse, the founders rejected “rumours about asset withdrawals” as part of a defamation campaign.

“They may call us stupid or crazy. […] They’ll say I ‘ran away’ with the money, when I in fact returned more of my own funds,” — said Su Zhu.

Regarding the yacht, one founder said it was purchased over a year ago and commissioned in Europe. Related transactions are publicly available.

Su Zhu rejected the notion of an extravagant lifestyle. He said he used a bicycle to go to work, and in his family’s ownership there are “only two houses in Singapore.”

“You’ve never seen us driving Ferraris and Lamborghinis. This portrayal of us is from a classic play […]. Funds explode, […] and then headlines appear that people love to discuss,” — said Su Zhu.

The co-founders disagreed with the claim that they disappeared and do not engage with creditors. They explained that hiding their whereabouts was a threat of physical violence and said they communicate with clients from “day one.”

At present both are en route to Dubai. Their aim is a “calm and orderly liquidation of the intricate tangle of their assets.”

On July 22 it was reported that the creditors’ appointed consulting firm Teneo had taken control of the hedge fund’s assets valued at $40 million. This is stated in court materials that came into Bloomberg’s possession. Bloomberg.

Assets include cryptocurrency, NFTs, stakes in startups and bank accounts. This is only part of the $2.8 billion creditors have claimed.

The 3AC founders still own or control “certain digital assets and bank accounts,” according to the documents.

Since July 1, the liquidators have sent information requests to around 40 individuals, as well as about 30 banks and exchanges that could have worked with the hedge fund.

As Colin Wu notes, the amount of unsecured liabilities of 3AC is between $1 billion and $1.5 billion.

In early July, 3AC filed for bankruptcy in a New York court.

Earlier, a Virgin Islands court ordered the liquidation of Three Arrows Capital.

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