Author's Note#
I need to make a slight excuse for not replying to many Twitter and WeChat messages; it's because I've been overwhelmed with messages lately. Many of these messages 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 matters to discuss, please feel free to get straight to the point. This way, I can respond quickly when I see it.
Additionally, some friends have provided 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 abilities; 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 completely 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, has not undergone strict auditing, and does not 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 made to borrowers with unstable repayment abilities, 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 and $18 billion.
3AC's main business is hedge funds, but it also has many investments in the crypto space. Although the exact funding positions of 3AC are not precisely known, detailed investment/participation/collaboration projects can be seen in the information publicly available on their 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 the timeline is not entirely accurate, so I hope everyone understands.
Let's go back to May 2022.
Before the collapse of Terra, 3AC had spent about $560 million to purchase 10.9 million LUNA and staked it on-chain. This investment is now worth only $670, effectively zero.
Additionally, according to well-known whistleblower FatMan, besides LUNA, 3AC obtained off-exchange funds through borrowing and deposited them into Anchor, with UST positions reaching nine figures, meaning over $100 million, which also amounts to zero.
Moreover, 3AC used its reputation in the crypto space to offer various projects, companies, and financial platforms high-yield financial products with APRs up to 8%, initially starting at 10%.
Since this financial product offering was widely known, it was essentially a done deal. Coupled with the fact that 3AC had borrowed funds that were deposited in Anchor, the source of returns for this "AAA financial product" was likely also from Anchor.
In this regard, 3AC is highly consistent with Lehman Brothers, both packaging high-risk financial products using their industry status as premium financial products, 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 survive?
Let's go back to June 2022.
The much-anticipated stETH-ETH liquidity crisis began. I won't elaborate 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 for the liquidity depletion of stETH was 3AC.
The recent issues with stETH mainly stem from circular lending, which in itself is not problematic. The issue arose from the liquidity depletion of stETH on Curve; although Celsius Network had 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. However, due to unfortunate 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 liquidation levels 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.
Because 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; the following image shows the content of their cooperation.
However, on June 12, due to market downturns, 8 Blocks Capital needed to withdraw funds for other trading operations but received no response from 3AC. On June 13, when they requested to withdraw more funds, 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 as of now, 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 they have already been notified to provide additional collateral due to the market downturn. 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; given 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 major client. Although they did not name 3AC, it is known that 3AC has business dealings with BlockFi and is a major 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, with a market value of about $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, much of that consists of illiquid assets (estimated to be $9 billion in illiquid assets). As a top hedge fund, 3AC would naturally not miss the opportunity to use these illiquid assets as collateral for borrowing.
BlockFi may just be one of many lenders; there are likely many financial institutions that have not yet been exposed. If these illiquid collateral assets face a liquidation crisis, 3AC will inevitably sell liquid assets to fill the leverage gap.
stETH
Returning to stETH, it has truly become a scapegoat. It needs to be stated very seriously that Lido's liquidity solution is currently not problematic, and stETH itself is also not an issue (non-technically).
Unfortunately, 3AC, as an investor in Lido, also holds a large share of stETH. However, when 3AC faced the collapse of Terra and the lending 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 reflects the advanced functionality of DeFi.
GBTC could not be redeemed before the launch of ETFs, and stETH also cannot be redeemed before withdrawals are opened. However, both can circulate on the secondary market at a discount.
The secondary market for GBTC is relatively complex; typically, GBTC's secondary sales require 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 gap. If a buyer cannot be found quickly, you may have to discount it by 50% to sell it quickly.
However, while stETH also cannot be redeemed, it can still be sold at market price through trading pairs on Curve. Generally, the price gap is about 2-3%, but due to the excessive selling pressure from 3AC, the price gap 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 open market. There is no need to find third-party agents like GBTC and then search for buyers to negotiate prices before trading; this process is overly cumbersome.
So if 3AC sells off GBTC, will it lead to a drop in BTC prices? In my view, the direct factor will not. Because GBTC cannot be liquidated with BTC, even if 3AC completes the sell-off, 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 this is directly caused by GBTC's sell-off; it is merely an indirect emotional panic.
Returning to stETH, the stETH held by 3AC has also been involved in circular lending on Aave for a long time. The previously circulated pool of $2.2 billion contained a lot of funds that were lent out by 3AC. However, due to the ongoing market downturn, 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 an article about it in the future.
The losses from Terra can be divided into two parts: one is the loss from directly investing in Luna. 3AC had spent about $560 million to purchase 10.9 million LUNA and staked it on-chain; this investment is now worth only $670, effectively zero.
The second part is the UST deposited in Anchor. The exact amount of this portion is currently unknown, but it has also reached nine figures, meaning over $100 million.
If the funds invested in Luna are likely 3AC's own funds, then the UST portion is the real bombshell. The source of UST funds is from 3AC's borrowing from 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 trigger for a larger collapse.
Potential Crypto Financial Tsunami Triggered by 3AC#
This topic is my personal subjective view and lacks sufficient evidence, so please take it lightly.
- A larger-scale crypto collapse
- A wave of bank runs on crypto companies
- Correlated collapses 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 impose much restraint. They can sell these locked tokens at a discount in an off-market manner.
Even if such transfer and sell-off actions occur, the public may find it difficult to notice immediately. Therefore, this has a significant lag, and those not privy to insider trading will not be aware of it.
By observing 3AC, there are also frequent investment behaviors in the secondary market for purchasing 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 careful.
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 financial supply chain-like structure means that if the financial institution at the top collapses, the crypto companies relying on it will 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 business ties with 3AC due to the favorable trading fee rates provided, resulting in funds being misappropriated by 3AC.
Crypto financial platforms (including exchanges, wallets, trust/asset management institutions) are also likely to be lured 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, these crypto financial platforms that have sold "AAA crypto financial products" three times to retail investors are also very likely to experience bank runs.
For example, Finblox announced yesterday that it would limit withdrawals. The announcement clearly stated that this was due to issues arising from its business dealings with 3AC, leading to withdrawal restrictions.
Correlated collapses of major lending companies
I don't have many examples in mind here, nor do I have sufficient information. However, I did catch a detail in a news article.
Two years ago, 3AC was already seeking "unsecured credit loans" within the circle. Unlike secured loans, lenders like BlockFi can cover losses through liquidating collateral and even profit.
However, unsecured credit loans do not have collateral, and losing everything means total loss. According to rumors on Twitter, although Nexo rejected 3AC's unsecured credit loan, 3AC found other lenders to complete the unsecured credit loan during the same period.
This may not be a single case; unsecured credit loans should not be limited to just once. The specific situation of these companies that provided unsecured credit loans to 3AC is still unknown. But we need to remain vigilant at all times.
To conclude with a quote:
Many people ask what stage we are in now compared to 2018. I want to say, I have never seen this scene in 2018.
Author: Liu Ye Jing Hong
WeChat Official Account: Weisiman Notes
Personal WeChat ID: liuyejinghong_
RSS3 Personal Homepage: liuye.rss3.bio
ETH Donation Address: liuyejinghong.eth
Discord: https://discord.gg/6tu2hpwvUh\\
Reply "web3" in the official account backend to receive free web3 learning resources
Reply "Industry Report" in the official account backend to receive the 2022 industry report for free
Recommended previous content:
《36. Discussing Crypto Profit Logic Again, Perhaps Useful for Those in a Confused Phase》
《34. An Alternative Perspective: Analyzing the Real User Needs of Web3 from Project Revenue.》\