Will Three Arrows Capital be the latest domino to fall in the crypto bear market?

The latest on-chain data has sparked speculation that crypto trading and venture capital firm Three Arrows Capital (3AC) is heading for bankruptcy . The company once had a strong portfolio, and its worst recent bet is arguably Terra 's Luna token. FatMan, a researcher from the Terra community forum, revealed that Three Arrows Capital once bought 10.9 million LUNA at a price of $559.6 million, which is now worth only $670.45.

New crises are coming one after another. The Block quoted people familiar with the matter as saying that the total liquidation amount of Three Arrows Capital on lending platforms such as Deribit and BlockFi was as high as $400 million. Subsequently, a new tweet from 3AC co-founder Zhu Su seemed to confirm these speculations, further sparking concerns about the potential chain reaction in the crypto lending market.

In traditional finance, liquidations occur when a company attempts to repay debts by selling certain assets at a loss. In the decentralized finance ( DeFi ) space, funds or protocols sell crypto assets to repay their debts.

Founded by Zhu Su and Kyle Davies in 2012, 3AC is known for promoting the "super cycle" theory and supporting tokens such as Avalanche , Solana , Polka dot and Terra in the early stage. It has grown into a "top stream" in the hedge fund circle. According to Bloomberg, its asset management scale once reached US$10 billion. However, among the assets endorsed by the three arrows, Terra has almost fallen to zero, Solana and Avalanche have fallen by 77% and 90% respectively since their respective record highs. The "top stream" of venture capital seems to be in trouble.

stETH “fire sale”

Market analysts pointed out that Celsius was not the biggest seller of stETH in the past few days.

“People think Celsius is the biggest stETH dumper, but Three Arrows is the biggest stETH dumper, they are dumping accounts and seed addresses they own, most appear to be to pay off their debts and outstanding borrowings,” wrote crypto trader MoonOverlord.

According to DeFi analyst DeFiyst, Three Arrows’ stETH “fire sale” began in May, just after Terra’s UST stablecoin crashed, and according to The Block, Three Arrows’ $400 million position has been liquidated. Crypto analyst Onchain Wizard reports that another $300 million in Aave and Compound are at risk of liquidation if the market continues to fall.

Analysts said that the price of stETH relative to ETH briefly fell to 95 cents in May: “Three Arrows Capital extracted 127,000 stETH liquidity from Curve ($246 million at the time), and they had been frequently operating between AAVE and wstETH before starting to sell off this week.”

Nansen data showed that a wallet belonging to Three Arrows Capital withdrew 80,000 stETH from the decentralized lending protocol Aave on Tuesday and exchanged 38,900 stETH (about US$45 million) in two transactions at a price difference of 5.6-5.9%.

According to DeFi analyst DeFiyst, Three Arrows Capital’s known collateral position is 212,000 WETH, about $235 million worth of Aave V2 and $183 million in total stablecoin debt, with a health factor of 1.08. If Ethereum plummets to $1,014, the collateral will face liquidation, resulting in irreparable losses.

Will stETH be the straw that breaks the camel's back?

stETH should trade at a 1:1 ratio with Ethereum, as the derivative token stETH can be redeemed for Ethereum once the mainnet merge occurs.

However, since June 9, the peg has shown signs of decline, falling to 0.89 at one point, and at press time on June 15, the ratio was 0.93. The market value of stETH has fallen from about $10 billion in early May to $4 billion.

stETH token issuer Lido clarified on Twitter that DEX prices will not affect holders' ability to redeem ETH at a 1:1 ratio.

Still, stETH holders who want to liquidate their positions are selling at a discount.All of this shows how vulnerable DeFi is to volatility.

Noelle Acheson, head of market insights at crypto market maker Genesis, believes that stETH is relatively illiquid. StETH's daily trading volume is hundreds of thousands of dollars, while ETH's daily trading volume is billions of dollars, which makes the prices of less liquid assets more sensitive to selling pressure. When a large player needs to sell its holdings, it can find few buyers, which drives down the price of stETH.

Another analyst, degentrading, warned of the risk of 3AC’s collapse, saying: “The collapse of 3AC would be huge. This is because they borrowed from every major lender. Think BlockFi, Genesis, Nexo, Celsius, if every lender took the hit from 3AC…..the inability to meet margin calls is the death knell for any hedge fund.”

3AC is in a very tight spot, and only a quick market rebound can help it regain its footing in the ecosystem and among VCs operating in the space. While co-founder and CEO Zhu Su said the company is “in communication with relevant parties and working on resolving issues,” Zhu once admitted that some of its predictions about the market were wrong.

“Sadly, the super cycle price theory is wrong, but cryptocurrencies will still thrive and change the world every day,” he said in late May.

Ryan Selkis, founder and CEO of Messari, commented: “Unfortunately, 3AC was on the wrong side of both investment transactions in GBTC and stETH.” But Selkis believes that with the Ethereum merger coming, 3AC is likely to find underwriters to help the company through any temporary bankruptcy.

Time will tell how Three Arrows Capital weathers this crypto winter.