Author's Note#
I need to make a slight excuse; I haven't replied to many Twitter and WeChat messages because I've been overwhelmed with messages lately. Many of them are just greetings, which I set aside after seeing them, and when I get busy, I genuinely forget to reply.
So if readers want to communicate or have something to discuss, please feel free to get straight to the point. That way, I can respond quickly when I see it.
Additionally, some friends have given feedback that my articles are too vague and lack a wealth effect. I would like to clarify that the vagueness is partly due to my own limited ability; there's no need for me to forcefully present myself as someone who knows everything. On the other hand, regardless of what I write about, the core purpose of writing is to express my own thoughts and reflections, so there is likely no wealth effect involved. If there were, I would have already become wealthy myself.
Therefore, if readers find value in my articles, they can treat them as mental exercises, reading what I think and what I write, and absorb some of my lessons from failure. If not, they can simply view them as entertaining articles.
I would also like to thank my WeChat friend @Lukennnnnn for providing a lot of material related to the 3AC incident. Most of the information in this article has been collected from public sources and has not undergone strict auditing, nor does it have legal effect; this article is merely a summary of information and secondary editing.
Main Text#
Background Summary#
In 2008, Lehman Brothers collapsed due to the subprime mortgage crisis. To briefly describe what subprime loans are: they are loans taken out by borrowers with unstable repayment capabilities, typically low-income individuals without stable income.
Lehman Brothers packaged these high-risk subprime loans as AAA-rated quality financial products, leading more financial institutions to invest in these AAA-rated products. Eventually, in the second half of 2007, the U.S. real estate market cooled down, and housing prices began to plummet. More and more borrowers defaulted, cutting off cash flow for some AAA-rated financial products. Quality assets instantly turned into toxic assets, triggering a global subprime mortgage crisis.
3AC (Three Arrows Capital), a top crypto venture capital firm, was founded in 2012 by Zhu Su and Kyle Davies, managing assets between $10 billion to $18 billion.
3AC's main business is hedge funds, but it also has a significant amount of venture capital in the crypto space. Although the exact funding position of 3AC is not precisely known, detailed investment/participation/collaboration projects can be seen on its official website.
What happened to 3AC?
In short, 3AC established high leverage in the crypto space through long-term collateralized lending/unsecured credit lending. To facilitate understanding, I will introduce a timeline concept here, but please note that the timeline is not entirely accurate.
Let's go back to May 2022.
Before the collapse of Terra, 3AC spent approximately $560 million to purchase 10.9 million LUNA and staked it on-chain. This investment is now worth only $670, effectively going to zero.
Additionally, according to well-known whistleblower FatMan, besides LUNA, 3AC obtained off-market funds through borrowing and deposited them in Anchor, with UST positions reaching nine figures, meaning over $100 million, which also equates to zero.
Furthermore, 3AC leveraged its reputation in the crypto space to offer various projects, companies, and financial platforms high-yield financial products with APRs of up to 8%, initially starting at 10%.
Since this financial product offering was widely known, it was essentially a done deal. Coupled with the previous borrowing of funds that 3AC had in Anchor, the source of returns for this "AAA-rated financial product" was likely also from Anchor.
In this regard, 3AC is highly consistent with Lehman Brothers, both packaging high-risk financial products as quality financial products using their industry status, providing services to many companies in the crypto space. Therefore, these crypto financial companies/custodians are likely to face corresponding liquidity crises/redemption crises as 3AC undergoes such a crisis. When the nest is overturned, how can the eggs remain intact?
Let's return to June 2022.
The highly anticipated stETH-ETH liquidity crisis began. I won't elaborate too much on the details of stETH-ETH here; those interested can refer to my previous article.
Previously, I believed that the liquidity depletion of stETH-ETH was primarily due to Celsius Network, although Celsius Network's collapse played a significant role. However, the decisive factor in the liquidity depletion of stETH was 3AC.
The recent issues with stETH mainly stem from circular borrowing, which in itself is not problematic. The problem lies in the liquidity depletion of stETH on Curve; although Celsius Network also sold a considerable amount of stETH, on-chain data shows that 3AC was the largest source of selling pressure for stETH.
According to some rumors, the fundamental purpose of 3AC selling stETH was to cover debts incurred from Terra. Unfortunately, due to bad timing or being targeted by other institutions (conspiracy theories), the panic triggered by 3AC's stETH sell-off directly caused the overall market to collapse, bringing debts closer to the liquidation line and forcing larger positions to be sold to prevent liquidation.
Let's return to the present.
An uncontrollable factor has emerged, as Danny from the well-known market maker 8 Blocks Capital exposed on Twitter that 3AC openly misappropriated user funds for other purposes.
Since crypto market makers are very sensitive to fee rates, many quantitative institutions and market makers choose to trade under 3AC's trading accounts to enjoy discounted rates. This is also one of 3AC's businesses, as shown in the following image.
However, on June 12, due to the market downturn, 8 Blocks Capital needed to withdraw funds for other trading operations but did not receive a response from 3AC. On June 13, they requested to withdraw more funds, and 3AC remained silent. At this point, 8 Blocks Capital discovered through monitoring that $1 million was missing from the corresponding fund account, but 3AC did not respond at all, and to this day, 3AC has not provided any response to 8 Blocks Capital.
It is worth noting that the funds of these market makers and quantitative institutions are also leveraged funds, and due to the market downturn, they have already been notified to provide additional margin. However, due to 3AC's lack of response, some funds have already been liquidated, prompting further market sell-offs.
The above is just one case exposed by 8 Blocks Capital; under the massive scale of 3AC, there are certainly more similar cases that have not been exposed. Their funding sources may be retail investors in the crypto space, which is why they choose to remain silent to avoid a widespread bank run.
Early this morning, the CEO of BlockFi announced on Twitter that they had liquidated a large client. Although they did not name 3AC, 3AC indeed has business dealings with BlockFi and is a significant client.
The CEO's wording was very subtle: “We believe we were one of the first to take action with this counterparty.”\
Does this imply that BlockFi is just the first to liquidate, and more companies will follow suit?
Main Sources of Losses for 3AC#
GBTC
According to public information, as of the end of 2020, 3AC was the largest holder of Grayscale's GBTC, holding 5.6168% of GBTC shares, valued at approximately $1.24 billion at that time. It is well known that GBTC cannot be redeemed and can only be sold on the secondary market; if Three Arrows needs to cover a margin call, they can only sell GBTC on the secondary market.
It is noteworthy that the core capital that allows 3AC to leverage many institutions is the GBTC they hold. According to Twitter sources from @hodlKRYPTONITE, the GBTC held by 3AC may have already been pledged as collateral to some institution, allowing them to obtain substantial funds for aggressive investments in the crypto space. However, with BTC prices having touched $20,000, this portion of GBTC may have to be sold on the secondary market due to liquidation pressure.
Although 3AC's managed assets were once inflated to $18 billion, many of those are illiquid assets (estimated to be $9 billion in illiquid assets). As a top hedge fund, 3AC would naturally seize this opportunity to use these illiquid assets as collateral for borrowing.
BlockFi may just be one of many lenders; there could be many financial institutions that have not yet been revealed. If these illiquid collateral assets face a liquidation crisis, 3AC will inevitably sell liquid assets to fill the leverage gap.
stETH
Back to stETH, it truly is a victim here. It needs to be stated very seriously that Lido's liquidity solution is currently not problematic, and stETH itself is also not problematic (non-technically).
Unfortunately, 3AC, as an investor in Lido, also holds a significant amount of stETH. However, when 3AC faced the collapse of Terra and the borrowing liquidation crisis, stETH, compared to other illiquid assets, could circulate through the stETH-ETH pair on Curve, making it the primary target for 3AC's sell-off.
Here is a rather ironic yet illustrative case that highlights the advanced features of DeFi.
GBTC could not be redeemed before the open ETF, and stETH also cannot be redeemed before the withdrawal opens. However, both can circulate on the secondary market at a discount.
The secondary market circulation of GBTC is relatively complex; typically, GBTC's secondary sales need to go through third-party agents and cannot be traded directly. Therefore, the pricing reflects that it cannot be traded at market price, resulting in a significant price difference. If a buyer cannot be found quickly, one might have to discount it by 50% to sell quickly.
However, stETH, while also not redeemable, can be sold at market price through trading on the stETH-ETH pair on Curve. Generally, the price difference is about 2-3%, but due to the excessive selling pressure from 3AC, the price difference has now shifted to 7%.
This shows that the DeFi market is more flexible than traditional financial markets, where illiquid assets can be sold at market price with lower slippage in the public market. There is no need to find third-party agents to find buyers, negotiate prices, and then trade; this process is overly cumbersome.
So, if 3AC completes the sale of GBTC, will it lead to a drop in BTC prices? In my view, the direct factor will not. Because GBTC cannot flow with BTC, even if 3AC completes the sale, it will only result in a larger discount for GBTC.
However, in the crypto space, indirect news may cause market price fluctuations. If such news were to emerge, it could likely induce market sentiment, but I still do not believe that this is directly caused by the sale of GBTC; it is merely an indirect emotional panic.
Returning to stETH, the stETH held by 3AC has also been engaged in circular lending on Aave for a long time. The previously circulated pool of $2.2 billion contained a lot of funds that were borrowed by 3AC. However, as the market continues to decline, the leverage of circular lending has already decreased significantly.
Terra
When it comes to Terra, there isn't much left to describe. I won't discuss the conspiracy theories related to LFG here; perhaps I will write a separate article on that later.
The losses related to Terra mainly consist of two parts: one is the loss incurred from directly investing in Luna. 3AC spent approximately $560 million to purchase 10.9 million LUNA and staked it on-chain, and this investment is now worth only $670, effectively going to zero.
The second part is the UST stored in Anchor. The exact amount is currently unknown, but it has also reached nine figures, meaning over $100 million.
If the funds invested in Luna are likely from 3AC's own funds, then the UST portion is the true meaning of a blowup. The source of UST funds is from 3AC's borrowing with crypto financial institutions and packaging high-risk financial projects (UST on Anchor maintaining a long-term 20% APY) as crypto "AAA financial products," providing financial services to many crypto companies at a maximum APR of 10%.
This part may be the fuse for a larger collapse.
Potential Crypto Financial Tsunami Triggered by 3AC#
This topic is my personal subjective view and does not have sufficient evidence to support it; please take it lightly.
- A larger-scale crypto collapse
- A wave of bank runs on crypto companies
- Correlated blowups of major lending companies
Larger-Scale Crypto Collapse
At the beginning of the article, I listed some projects and companies that 3AC has invested in. 3AC will inevitably acquire crypto tokens or equity from these.
Although there is a high probability of lock-up, for institutions, lock-up does not have binding force. They can sell these locked tokens at a discount in an off-market manner.
Such transfer and sell-off behaviors, even if they occur, are difficult for the public to notice immediately. Therefore, there is a significant lag, and those not privy to insider trading cannot know about it.
By observing 3AC, there have also been frequent secondary market purchases of tokens. Therefore, these publicly held crypto positions also need to be treated with caution, as these tokens have very high liquidity. If 3AC takes selling actions, it could trigger a small collapse.
At the same time, 3AC also has undisclosed wallets, which means there are many undisclosed positions. Please be very cautious.
Wave of Bank Runs on Crypto Companies
This is very easy to understand; the composition of crypto finance is interlinked, whether in DeFi or CeFi. This structure, similar to a financial supply chain, means that once the top financial institution collapses, the crypto companies relying on it also face significant crises.
The market maker 8 Blocks Capital mentioned in the article is a good example. Market makers and quantitative institutions may have their funds misappropriated by 3AC due to the favorable trading fee rates provided by 3AC.
Crypto financial platforms (including exchanges, wallets, trust/asset management institutions) are also easily induced by the "AAA crypto financial products" with 10% APR offered by 3AC, leading them to raise large amounts of funds from users. Now that 3AC is facing a severe bank run crisis, those crypto financial platforms that sold the "AAA crypto financial products" to retail investors are also very likely to experience bank runs.
For example, just yesterday, Finblox announced restrictions on withdrawals. The announcement clearly stated that the restrictions were due to issues with 3AC's business.
Correlated Blowups of Major Lending Companies
I haven't thought of many cases here and don't have sufficient information. However, I did catch a detail in the news.
3AC sought "unsecured credit loans" in the circle two years ago. Unlike secured loans, where lenders like BlockFi can cover losses through liquidating collateral, unsecured credit loans have no collateral, and losing everything means total loss. Rumors on Twitter suggest that although Nexo rejected 3AC's unsecured credit loan, 3AC found other lenders to complete the unsecured credit loan.
This may not be a single case; unsecured credit loans should not be limited to just once. The specific situation of the companies that provided unsecured credit loans to 3AC is still unknown. However, vigilance must be maintained at all times.
To conclude, I would like to quote a saying:
Many people ask what stage we are in compared to 2018. I want to say that I've never seen this scene in 2018.
Author: Liu Ye Jing Hong
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