Crypto Hedge Fund Three Arrows Capital Considers Asset Sale, Bailout

Cryptocurrency-focused hedge fund Three Arrows Capital Ltd. has hired legal and financial advisers to help find a solution for its investors and lenders, after suffering heavy losses following a massive sale of digital assets in the market, the company’s founders said on Friday.

“We always believed in crypto and we still do,” Kyle Davies, co-founder of Three Arrows, said in an interview. “We are committed to resolving issues and finding a fair solution for all of our constituents.”

The nearly decade-old hedge fund, which was started by former classmates and Wall Street currency traders Su Zhu and Mr Davies, had about $3 billion in assets under management as of April this year.

This was shortly before a sudden crash in the values ​​of TerraUSD, a so-called algorithmic stablecoin, and its sister token, Luna, in mid-May.

Three Arrows is exploring options such as the sale of assets and a bailout by another company, Mr Davies said. The fund hopes to reach an agreement with creditors that would give it more time to develop a plan. The company is still in business as it seeks a solution.

Three Arrows was part of a group of major investors who participated in a billion-dollar token sale earlier this year by Luna Foundation Guard, a nonprofit created by South Korean developer Do Kwon, the creator of TerraUSD. The funds went to a bitcoin-denominated reserve for the stablecoin and was intended to help maintain the value of TerraUSD at $1 per coin.

Mr. Davies said Three Arrows invested around $200 million in Luna as part of the deal, a sum that was effectively wiped out when TerraUSD and Luna went worthless within days.

The two cryptocurrencies were previously among the top 10 digital coins before losing a combined $60 billion in market capitalization last month, he added. Prior to the collapse, a few people in the crypto industry had expressed concerns about the stability of TerraUSD and its reliance on traders to act as its backstop, saying that this mechanism could allow for a potential downward spiral.

“The Terra-Luna situation caught us off guard,” Davies said, adding that the sell-off was unprecedented. The sale of bitcoin by the Luna Foundation to help support TerraUSD also deepened bitcoin’s decline in value in May.

Mr Davies said Three Arrows was able to weather Luna’s losses, but the ensuing cascade of events that sent the prices of bitcoin, ether and other cryptocurrencies plummeting in recent weeks created more problems, he added.

Credit conditions have tightened dramatically as the value of digital assets has fallen across the board, leading some lenders to demand partial or full repayment of loans they previously made to crypto investors. The rapid rise in interest rates in the United States, the result of attempts by the Federal Reserve to contain high inflation, also aggravated the massive selling of riskier assets.

Crypto’s total market capitalization, which had hit nearly $3 trillion in November last year, had fallen to $910 billion on Friday, according to data provider CoinMarketCap. Last weekend, Celsius Network LLC, a widely used cryptocurrency lender, abruptly froze customer withdrawals, trades and transfers between accounts, blaming what it said were extreme market conditions.

“We weren’t the first to be affected… This is all part of the same contagion that has affected many other businesses,” Mr Davies said.

He said Three Arrows is still trying to quantify its losses and assess its illiquid assets, which include venture capital investments in dozens of private cryptocurrency-related businesses and startups.

“We are the biggest investors in the fund, and our intention has always been for everyone to succeed there,” said Mr. Zhu, the other founder of Three Arrows.

At the start of 2021, Zhu predicted bitcoin would enter what is known as a growth supercycle with prices steadily rising as the cryptocurrency gained popularity. In late May, as the market selloff was underway, he tweeted that “the Supercycle price thesis was sadly wrong, but crypto will continue to thrive and change the world every day.”

Three Arrows’ sudden downfall follows the company’s previously strong performance record. Zhu and Davies launched their fund in late 2012 with just $1.2 million. It originally focused on trading emerging market currencies before branching out into cryptocurrencies massively in recent years, multiplying the fund’s investments as the value of bitcoin and other digital assets rose.

The company is known for holding large positions in Grayscale bitcoin Trust and “Lido staked ether” tokens, which have also suffered losses recently. The latter is derived from the cryptocurrency ether which is locked until the Ethereum network switches to a less energy-intensive model. These tokens recently traded at a discount to Ether itself.

Nichol Yeo, a partner at the Solitaire LLP law firm that advises Three Arrows, said all investors in the fund are institutions or wealthy investors. He added that the company was keeping Singapore’s financial regulator, the Monetary Authority of Singapore, informed of its recent developments.

Just before the latest downturn, Three Arrows said it planned to move its headquarters to Dubai, where the digital asset industry is booming. The firm operated as a regulated fund manager in Singapore until last year when it moved its domicile to the British Virgin Islands as part of its relocation plan.

WSJ’s Dion Rabouin explains why Wall Street is now betting big on crypto and what that means for the new asset class and its future. Photo composition: Elizabeth Smelov

Caitlin Ostroff and Vicky Ge Huang contributed to this article.

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Sallie R. Loera