Breaking silence: Three Arrows founder reveals details of collapse for the first time

By Joanna Ossinger, Muyao Shen & Yueqi Yang, Bloomberg

Editor: Moni, Odaily

After five weeks in hiding, Three Arrows Capital founders Su Zhu and Kyle Davies spoke to Bloomberg at an undisclosed location.

They talked about a lot of inside information and regretted this crypto journey. They admitted that Three Arrows Capital's risk management had a systematic failure and that credit liquidity was greatly affected due to wrong bets. However, the two refused to disclose where they were, but a lawyer on the phone said their final destination was the United Arab Emirates.

Kyle Davies (left) and Su Zhu (right), May 2021

Su Zhu and Kyle Davies, 35, were good friends in high school. They worked together to build Three Arrows Capital into a crypto trading behemoth. However, due to bad speculation and leveraged trading, Three Arrows Capital eventually triggered a domino explosion - with the collapse of Three Arrows Capital, a series of chain reactions occurred: creditors went bankrupt, the crypto market sold off, and brought huge losses to Bitcoin and other token holders.

The pair described it as a "regrettable debacle" as they headed to Dubai.

When Excessive Leverage Meets Crypto Winter

Recently, a court in the British Virgin Islands ordered the liquidation of cryptocurrency hedge fund Three Arrows Capital, saying they were owed more than $2.8 billion in unsecured claims. Court documents show that this number is expected to rise significantly. So far, the liquidators overseeing the bankruptcy have taken control of assets worth at least $40 million.

Su Zhu and Kyle Davies have long been the most well-known cryptocurrency bulls, but driven by leverage, they have gradually put Three Arrows Capital in the "center of the explosion." As cryptocurrencies collapsed, Three Arrows Capital fell into trouble. Su Zhu said: "We positioned ourselves in a market that would not eventually crash," Kyle Davies added: "We stubbornly believe that the crypto market will always be good, and we have all, almost all of our assets in Three Arrows Capital. Then, in good times, we did the best, but in bad times, we lost the most."

At the same time, Su Zhu and Kyle Davies believe that they are not the only ones with problems in the market. Bad market conditions, interconnected one-way bets and loose lending strategies have led to the bankruptcy of companies such as Celsius Network, Voyager Digital and BlockFi.

“It’s not just us, it’s not surprising that companies like Celsius have problems,” Zhu said. “We have our own capital, we have our own balance sheet, but we also take deposits from these lenders and then we generate income for them. So if we are in the business of taking deposits and then generating income, then you know, that means we will end up doing similar transactions.”

Clearly, Su Zhu and Kyle Davies are shirking responsibility, considering that they have previously been strong advocates of crypto assets.

Just this week, Su Zhu was accused of defamation after it was revealed that he had paid a down payment on a $50 million yacht before Three Arrows collapsed. “The boat was bought more than a year ago, commissioned and used in Europe, and the yacht has a complete source of funding,” Su Zhu explained. Su Zhu denied the claim that he enjoys a lavish lifestyle, noting that he rides a bicycle to get off work every day and that his family “only has two houses in Singapore.”

Three Arrows Capital's office in Singapore

"We've never spent a lot of money in any club. You know, we've never seen me driving around in Ferraris and Lamborghinis, and I think this smear campaign against us is just from the classic script, you know, when things like this happen, when bombshells break, these are the headlines that people like to see."

The tragedy caused by Luna

Su Zhu and Kyle Davies admitted that they suffered heavy losses in trading Luna and the now-defunct algorithmic stablecoin UST, and they were frankly surprised by the speed of LUNA's collapse. Su Zhu explained:

“What we didn’t realize was that Luna would be able to go almost to zero in a matter of days, which would have triggered a credit crunch across the industry and would have put tremendous pressure on all of our illiquid positions. In retrospect, Three Arrows was probably too close to Do Kwon, the founder of Terra.”

"When Do Kwon moved to Singapore, we started to get to know him directly. And we just felt that the project would do something very big and had done well." Su Zhu admitted that he had misjudged LUNA. "LUNA's initial performance was too good, you know, too big, too fast. It was very much like a long-term capital management opportunity for us. Others had this kind of transaction, and we all thought it was good. LUNA grew too fast."

One of the transactions involved an Ethereum-related token called stETH, which is designed to unlock the liquidity of staked ETH and be widely used in DeFi. Once the long-awaited upgrade of the Ethereum blockchain takes effect, each stETH can be exchanged for one ETH, but the turmoil caused by the collapse of Terra caused its market value to fall below that level, resulting in other investors selling at risk.

Su Zhu further said: “Because Luna just happened, it is very much like an epidemic, and people will say, well, is there anyone who also uses long-term staked ETH instead of being liquidated ETH as the market falls? So the entire industry is effectively looking for these positions, and you know, in the end these people are hunted down.”

Still, Three Arrows was able to continue borrowing from large digital asset lenders and wealthy investors when the market crisis first emerged — until they blew themselves up.

After Luna’s collapse, Su Zhu said lenders were “satisfied” with Three Arrows’ financial health and even allowed them to continue trading “as if nothing was wrong” — many of those loans required only very small amounts of collateral, as court documents now show.

“So I just think that, you know, during that period, we continued to do business as usual. But yeah, after that day, when Bitcoin went from $30,000 to $20,000, you know, that was very painful for us, and that was the final nail in the coffin for us. If we had been more involved in the game, we would have seen that the credit market itself was a cycle where, you know, we might not have been able to get additional credit when we needed it.”

“Locked” by GBTC

Grayscale Bitcoin Trust (GBTC) is a closed-end fund that allows people who can’t or don’t want to hold Bitcoin directly to buy shares of the fund that invests in them. For a while, GBTC was one of the few crypto products regulated in the U.S., so it had its own market and was so popular that its shares consistently traded at a premium to the value of the Bitcoin it held on the secondary market.

On the other hand, Grayscale allows large investors like Three Arrows Capital to buy shares directly by handing over Bitcoin to them, and these GBTC holders can then sell their holdings to the secondary market. This premium means that any sales can result in a significant profit for large investors. The last filing with regulators at the end of 2020 showed that Three Arrows Capital was the largest holder of GBTC, with a position worth $1 billion at the time.

There was a hitch to the strategy, though: Shares purchased directly from Grayscale have a six-month lockup period. Starting in early 2021, that limitation became a problem, as GBTC’s price slid from a premium to a discount — with one share worth less than the bitcoin backing it — and the product had to face stiffer competition from other similar products. As the months passed, GBTC’s discount grew, so-called GBTC carry trades no longer worked — especially hurting investors who used leverage to try to boost returns — and Three Arrows suffered as a result.

GBTC trading at a discount

In the narrative of Su Zhu and Kyle Davies, part of the reason for investing in GBTC was their herd mentality: “The profits were very large at the time, and we managed to do it in the right window period, and then like everyone else, we started to lose money, and it turned negative. Our trust was discounted, and the discount was much greater than anyone imagined.”

Risk-free returns? Not happening!

There is never an investment without risk.

In response to questions about what went wrong at Three Arrows Capital, Su Zhu said that years of bull market had made him overconfident in the market, which not only injected the thinking power of him and Kyle Davies, but also injected it into almost every credit infrastructure service provider in the crypto industry.

“You always need to be aware of what you’re getting into — whether it’s risky or not when you’re choosing to invest,” Zhu said. “For us, if you go to our website, we always have a lot of disclaimers about crypto risks. We never market ourselves as risk-free.”

When crypto markets first started to decline in May, he said, “we met all of our margin calls, so we felt like people should understand there’s a risk. When we do well, lenders benefit a lot because when we do well, they can say, look, I’m making $200 million a year on lending at Three Arrows, a 10x return. Now, it’s the exact opposite.”

Currently, Su Zhu and Kyle Davies are heading to Dubai, and Su Zhu hopes to liquidate his private assets step by step. Su Zhu revealed that some people in the crypto industry even issued death threats to them, so now he hopes to ensure personal safety and keep a low profile, "which is good for everyone."

Su Zhu concluded: "Given our plan to move our business to Dubai, we must now go there as soon as possible to assess whether we can move the company there as originally planned, or whether there will be other ideas in the future, but the current situation is very unstable and the main focus is to help creditors repay."