and were left staring down the barrel
of a $3.5 billion bill.
Our story starts with two guys who
met at college, Zhu Su and Kyle Davies.
Both pretty regular guys who
had regular finance careers.
They got a good education at an elite
Massachusetts boarding school, studied at Columbia,
and then learned the ropes trading derivatives at Credit Suisse.
So far, fairly normal.
Well, it all starts with the little risk.
In 2012, that faithful year when the world was
supposed to end, our two heroes did something unusual
for a couple of guys in their mid 20s.
They started a hedge fund called Three Arrows Capital, (3AC),
which, like most hedge funds, essentially is a
and hopefully, hopefully get great results.
Yeah, we'll get to those results.
Based in the British Virgin Islands and licensed in
Singapore to manage other people's money, 3AC wasn't big,
wasn't flashy, and had a simple but unexciting
business model: find price gaps in emerging market currency
derivatives and exploit them to make money.
Do this enough times, you'll make a decent profit.
And for a few years, this satiated them.
But then 2016 happened, and the world of digital
assets started to rear its head big time.
To most back then, this world of
cryptocurrencies was exciting, intriguing and new.
But to Zhu and Davies, it
was something much, much more.
It was an industry that was
emerging, vibrant and full of potential.
Zhu himself felt it was an example of Amara's law,
which means that the technology would be overestimated in the
short run, but underestimated in the long run.
He believed crypto was going to change
the world, just like the Internet did.
People doubted dot coms and the
Internet, but look what it became.
But he and Kyle also
spotted something peculiar about crypto.
The industry was filled, absolutely filled,
with tons of price gaps.
The exact kind of price gaps they'd spent the
last few years learning to take advantage of.
It was perfect, money making time.
- That's a bingo.
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So 3AC got into the crypto game
and started making a major name for themselves.
Their strategy began by trading in Bitcoin
and Ethereum derivatives, but they soon developed
a nice, well rounded portfolio.
But more importantly, they developed a knack for
borrowing money from all corners of the industry.
And this part is crucial to understand.
They were borrowing so much money and using that
money to invest in projects that they liked.
Which meant they had a massive
exposure in the crypto market.
They became so reputable that Chase and Bank of
America helped them with brokerage agreements.
and slowly but surely, they gained an enormous,
enormous amount of leverage in the space.
Eventually, 3AC, our little hedge fund that could, grew
into a $3 billion Giga Chad giant of the crypto world,
and Zhu and Davies always described it in the same way,
Like I said, Giga Chads.
- Do it.
And their Twitter personas backed it up
where they claimed traditional
investing was for boomers.
I know, what a scorchingly hot take.
Soon they were pretty much the
go-to guys in the industry.
But it wasn't all pretty well.
They were brokering deals and introductions,
amassing fanboys on Twitter, venture investing,
and even managing corporate treasuries.
Some were accusing them of using psyops on
Twitter to influence their very own profits.
I'll let you decide.
Zhu denounced Ethereum.
He said he was quitting the currency,
which led the price to fall.
But according to Nansen Analytics, about one month
later, 3AC bought about 150,000 Ethereum.
But by 2018, Zhu had put them on the map.
You see, in 2018, crypto was in bad shape.
By September of that year, prices had crashed
by 80%, a plunge worse than the dot com bubble.
Naturally, investors were panicking and there was
a lot of doomsday talk floating around.
But then in walk Zhu, with this tweet,
And you know what?
He was right.
Crypto rebounded and Zhu's tweet made him an
icon of the industry, which, alongside his hypnotizing
new belief system, started getting him real followers.
He called it the super cycle, which essentially
meant that in the long run, Amara's Law
would be proven correct in crypto.
This technology would help fuel a revolution and
create a new internet on the blockchain.
Crypto wasn't just here to stay,
it was going to change everything.
A big idea backed by an even
bigger bullish conviction about the market
HODL no matter what, and you will be rewarded.
- I definitely think Bitcoin's price goes over
a million, goes over $500K, it's not going to
be driven as much by retail anymore.
It's going to be driven a lot more by larger players.
- Now, this might sound strange, as any traders should know,
that currency prices can swing all over the place.
Why would crypto be any different?
But Zhu and Davies were serious.
They believed crypto was going to be fine, and
HODL was really the only move for serious investors.
And you know what?
People believed it.
Their conviction was compelling.
And the accuracy of Zhu's
2018 prediction only reinforced this.
They managed to get uncollateralized or somewhat collateralized
loans from massive institutions in the industry with
an almost 700 million dollar uncollateralized loan from
Voyager Digital, which basically means if everything went
wrong, Voyager would just kind of hope that
3AC pays it back.
So Zhu and Davies were on top of the world.
What could possibly go wrong?
Well, when you're on top of the world,
the only way you can go is down.
And that's exactly what happened next.
The downfall starts when a new player enters the scene.
And for our sophisticated investors,
they're too delicious to resist.
The player is the Grayscale Bitcoin Trust, GBTC.
And they're pretty revolutionary.
Not only do they let people hold Bitcoins by
acting as a fund that they can invest in,
but at the start, they're one of the only
US regulated crypto products, so they rapidly gain attention.
In fact, GBTC got so popular that its
shares were trading higher than the value of
the Bitcoin it was composed of.
Insane how hot these things can get.
But that's not what made it delicious to 3AC.
What made it delicious is that GBTC gave
funds like 3AC backdoor access into the trust,
which meant they could buy shares at
a cheaper price than your average trader.
The method here was simple.
You purchased your shares using Bitcoin, and
those shares are worth more than the
Bitcoin you just bought them with.
Now, this made 3AC salivate with delight.
Here was the plan.
Step one, borrow Bitcoin.
Step two, use it to buy GBTC shares.
Step three, use the shares as
collateral to borrow more money.
Leverage stacked on top of risky leverage.
Nobody is surprised by the fact that
the end of 2020, when GBTC last filed,
3AC was its biggest holder.
Its position? A touch over $1 billion.
Now, things aren't all great because there's a
clause that says if you buy shares, they
are locked up for six months.
But if you're using the
shares as collateral, who cares?
You can use that asset now anyways.
And if you believe, as Zhu and Davies
did, that crypto only goes up, then there's
really nothing to worry about here.
Well, naturally, the price of GBTC did change
in early 2021, ProShares Bitcoin strategy ETF
showed up on the scene and caused GBTC's
price to dive below Bitcoin and keep falling.
Not good for 3AC.
But remember, they've got their fingers
in a lot of pies.
One of these pies was decentralized finance.
DeFi startups.
These startups had a simple enough goal.
Take Wall Street, digitize it and
its deposit, tracking, trading, borrowing and
ensuring functions, but without the regulation
all on the blockchain. It's perfect.
But before they could do that, DeFi startups
needed as many people's crypto savings as possible.
They needed a pitch to get people in.
And it was simple.
DeFi businesses, on the other hand,
were offering depositors double digit yields.
One such DeFi business was
Anchor Protocol, offering a 20% return.
Tempting stuff.
It got me.
But to earn that 20% rate, you had to hold UST.
UST was a token created by a guy
named Do Kwon, king of the lunatics.
That should tell you where this is
going, but I'll show you anyways.
UST was linked to another coin created by Kwon
called Luna, which is confusing, but the arrangement worked.
So what does 3AC do?
- There's more. I want it all.
- By February 2022, they're reaping yields from
Anchor, and rather than stopping there,
And as it went, Luna and UST
eventually reached $60 billion in combined worth.
They were no joke.
Except this is where everything starts to go very
bad for Zhu and Davies and 3AC, because
Luna's price collapses and kickstarts a crypto collapse like-
Here's what happened. Luna tanks and 3AC, which was extremely overexposed
to Luna, suddenly finds itself facing a problem.
It's extremely over leveraged, having taken loans from
just about every big player in the industry,
and now it can't pay back those loans.
They start getting margin calls and
the situation just gets worse.
nobody from big whales to small
investors knows how exposed they are.
So what do they do?
They start ***ing their pants and begin pulling money.
This is financial crisis 101.
Prices fall dramatically, so people become
desperate and get out, regardless of
whether they lose money or not.
And this sends prices even lower.
Fear breeds more fear, and it's just a
death spiral all the way to the bottom.
This is exactly what happened in
2008 with a subprime mortgage crisis.
Except with crypto, there's a big difference here.
In 2008, when banks started going under, there was
a big, fat central bank ready to step in
and save everyone's ass with a bailout.
With crypto, not so much.
Crypto has little to no consumer protections and
nobody's there to clean up the mess.
So when the crypto market crashed, it
crashed hard and everyone was just out.
3AC started defaulting on loans, causing everyone
they borrowed from, like Voyager Digital and their
uncolateralized 700 million dollar loan to tank.
This is bad and only sends more of
the crypto market into panic, as more and
more institutions like Blockchain.com, BlockFi, BitMEX and Derbit
all face some kind of exposure to 3AC
and generate even more pantshitting.
So what did Zhu and Davies do?
They met with executives from several crypto exchanges
to discuss the possibility of a bailout.
The classic Wall Street play.
It's never failed before, right?
Hey, we screwed up our gamble.
Help us
please?
Anyone, please?
Sadly, it doesn't work out, and the exchanges
just essentially tell them to take a hike.
And is this really surprising?
The crypto market is currently imploding.
Many tech companies have the same issue.
we can't easily figure out its true value.
If you have a business that profits $1 million a
year, we could figure out what that business is worth.
But if you have a business with a
million in revenue but no profits, we'd have
a much harder time setting a price.
In other words, Zhu and Davies
were victims of themselves here.
So how did the story end?
Well, Voyager Digital filed
for chapter eleven bankruptcy.
3AC exposures across the industry led
to countless investors having their assets frozen
and inaccessible, damaging people's lives.
The crypto market is in rough shape still,
3AC is ordered to be liquidated.
And 3AC was left when the dust had cleared with
a total bill to 27 creditors of $3.5 billion.
A staggering brutal blow for the crypto market, but a
ludicrous achievement for a ten year old hedge fund.
And as for Zhu and Davies themselves,
well, nobody actually knows where they are.
They've kind of vanished.
I'm seriously, no one knows where they are.
And so far, they've been
uncooperative with the liquidators.
But there has been some character growth.
Zhu referring to his earlier super cycle theory, which reinforced
the premise that crypto could only to go up.
Yeah, he came out and
admitted he was regrettably wrong.