3AC vs. FTX: Why 3AC's Collapse Hit Harder - TOKEN2049 Singapore 2023

hi everyone I'm Ryan I'm the deals editor at the Block joined by Peter Smith CEO of blockchain.com we're here to talk about why three arrows Capital the clutch three arrows Capital hit harder and we've got 15 minutes to do it so we better get started um for those of you who have been living under a rock uh three arrows blew up just before this event last year was one of the biggest hedge funds in the space um invested in tokens invested in startup Equity uh bought nfts went bankrupt I think in about July last year um and it's been in the bankruptcy process ever since I think it owed creditors in the region of 3.5 billion dollars plus when it went bankrupt and here we have Peter to talk about why that was such a big deal for the space so Peter maybe we could just start um quick introduction to yourself and also how blockchain.com fit into this picture of 3ac sure um and it's great to be here today I've never really done one of these talks like adjacent to a nightclub sound which I've been doing crypto and crypto events now for almost 10 years one month shy of that so it's rare for me to have a a new experience but uh it's good to have one so blockchain.com runs a large institutional business in the space where we do a lot of OTC trading both in spot and derivatives as well as providing margin loans as well as structured credit and three arrows was a long time client we were one of their sort of first counter parties when they were getting started out I think one of the interesting things to reflect on with three arrows is that well they did go bankrupt and lose a lot of money for a lot of folks they were for a few years probably the dominant hedge fund in the space they were by far the largest the most aggressive and frankly one of the most talented uh sets of Traders out there in the market and of course as has been written about a lot since they got off side of the market and went bankrupt and it's interesting to reflect on why we were a service provider to three hours Capital We Were A lender to three hours capital and so we've seen a lot of the sort of Rise of three arrows as well as the fall and then as a very active participant in the institutional Market as well as the global crypto markets we've seen a lot of the effects of that as it's played out over the last year okay I don't know we've we've I mean we'll talk about it throughout the session but you see sort of three big reasons don't you why this this sort of triggered such a domino effect in in crypto credit last year what can you briefly outline those for us sure so I think the first thing is that crypto had been a relatively High trust environment for a long time it was sort of a very small group of people that built most of the big crypto companies uh funds investment firms and there was this sort of like almost naive trust that was based on the idea that we were all had a common purpose or common mission of building a new Financial system and so there's probably a higher level of trust between counterparties uh than maybe was warranted and I think that the the three arrows collapse really was the first thing that made a lot of people question that and it it made the market really nervous about counterparty risk and so you saw after that a lot of institutional funds began pulling Capital pulling credit lines which began to exacerbate the sort of Market online that we were experiencing this time last year and that put a lot of pressure on crypto companies all throughout the market which later went on to blow out you know notably FTX and what have you but it wasn't really anything specific that the three arrows did besides their default on their on their lenders it was this sort of you woke up one day and you realized that you had gone from a high trust common Mission environment to a space where that probably wasn't true anymore because of how big it had gotten and it made people really nervous and aggressive about managing their counterparty risk which in the long term is probably a really good thing for the resiliency and maturity of the space uh you know in Trad five they're not United by a common purpose they just kind of manage ruthlessly but it was definitely a paradigm shift for the market participants at the time yeah the second way that it really impacted things is that most of the major lenders including ourselves called back all of their under collateralized loans and one of the big borrowers of crypto in this space is actually crypto Market making firms and so over the last year you've seen a real collapse of liquidity in the market the global crypto markets today are maybe 15 as liquid as they were 16 months ago and so that liquidity has given rise to a lot of intraday tick-by-tick volatility and it's made it very hard to execute larger trades in the space and so that pullback of credit has really changed this shape and Market microstructure of the global crypto Market in a pretty fundamental way and then the third thing is you know just as in traditional Finance most loans to big companies institutions hedge funds are made by banks that Source Capital from you know retail or other customers and then lend that Capital out and then they have a provision on their balance sheet that says if we lose money lending we're going to use this provision to to make our customers whole on the other side that's basically what was going on in crypto except a lot of crypto companies had not made a big enough provision to absorb losses if their lending book took a loss and so when the largest hedge fund in the space went bankrupt there were a lot of Downstream bankruptcies that impacted millions of retail customers and so you know we're thinking of Voyager here we're thinking of block five we're thinking of Celsius and then you know a variety of other players in Asia and Europe as well who had a lot of exposure to three arrows or firms that looked like three arrows and the number of customers you know retail customers were impacted by that was you know Millions right um and much greater scale than than even the FTX blowout just to come back to that point about trust which I suppose is slightly ironic given that we're in crypto where people are so fond of talking about trustless systems and things like that but um you know why do you think it was the case so that well sorry was it because of how the environment was at that time that people didn't have sort of higher disclosure requirements when it came to you know holding three arrows to account about what's your nav at this point you know what's your leverage at this point you know what like where does the fund sit so you know I don't know anything about other folks business arrangements with three arrows capital and uh I think that you know for me I can only speak in a sort of General sense about the three Arrow situation the reality is that disclosures and risk reporting only work when the reports submitted are accurate and so I think sometimes you see like on Twitter like you know why wasn't the reporting you know why weren't people asking for more reporting yeah um most lenders at do ask for a lot of reporting but that is based on the assumption that you're given accurate reports right and so I think in time we'll get more reports from you know the Liquidators of three arrows and we'll understand how accurate or not accurate that reporting may have been but it does kind of rely on having accurate reports and making Provisions for credit losses on your balance sheet which a lot of other crypto companies failed to do um I think the other thing to say about the lending space in crypto is you're dealing with a really volatile asset class like this model of sort of prime brokerage and margin credit trading was ported over from tradfly and there's no assets really there aren't any sectors in tradify that move with the same volatility as crypto and so I think managing credit risk and counterparty risk in crypto is probably uniquely challenging in a way that most of the models from tradvi and risk models were totally unprepared to tackle in the digital asset space I guess you've kind of alluded to an answer on this front but do you think the reports you received were inaccurate I can't comment on that question at this time okay what about the bankruptcy process itself it's obviously been quite uniquely complex it's uh you know there's been back and forth in some ways between the founders and teneo the Liquidators in other ways it seems like they're not perhaps working together as closely as they might be does that ramp up the impact of this sort of an event on you know retail customers perhaps but also the companies that are involved in an Ideal World when a trading firm goes biased they the staff of the trading firm help unwind that firm's positions and as orderly and expeditious fashion as possible that you know from reading the public filings has certainly not been the case with the three arrows liquidation um you know there's there's this sort of strange Habit in crypto of having like discussions over Twitter which uh I still don't understand after 10 years of doing crypto and it's definitely a very heated discussion between the founders of three arrows and the Liquidators uh on on Twitter that's quite quite valid and very frustrating to watch yeah I know Arthur Hayes has been trying to reach out to them directly via Twitter in your position as a creditor do you mostly just deal directly with tenno and that's kind of that's kind of it yeah so we work via the Liquidator um we had filed to put three arrows capital in liquidation after we made a margin call that they were unable to meet yep um and uh someone from our team from our legal team is on their creditor committee uh that is kind of responsible for overseeing the Liquidators um it's not something I personally work on yeah but it's definitely something that someone at blockchain.

com works on okay what about the the question of um taking on more leverage as things were going wrong which is something that teneo has talked about and sort of has suggested that you know some of the loans they took in those final days before the bankruptcy which I suppose were to try and save the thing and and keep it going potentially exacerbated the damage that it that it did do you have a view on that yeah so teneo has done a lot of work to reconstruct sort of the final year of three arrows one of the things that they have said publicly is that three arrows continued to borrow right up until the end I think their last loan was maybe only eight days before they were you know under and I think that I will probably reserve my full View for the final report but if it turns out that they were knowingly as a fund borrowing that they were unable to have any sort of liability to repay and that they weren't being honest about the financial position of the firm that would be incredibly disappointing to find out okay with you know just over a year removed from the bankruptcy itself and obviously a hell of a lot has happened in that time but where do you think crypto credit markets are right now you're still one of the you know the bigger lenders in the space um you know where are we relative to let's say a year and a half ago you've had a massive contraction in the credit markets and that's what I was talking about in reference to a contraction and liquidity as well I don't see the credit markets coming back in the same way I think applying the models from tradfi to crypto wall work I think you'll see credit stay over collateralized which is where most credit deals are today they're over collateralized sort of like margin facilities which lenders including ourselves and Galaxy are happy to provide really only ourselves and galaxies survived right so it's a very small Market um beyond that I think most of the credit provision in crypto will have to be on chain okay and so you've seen a lot of that sort of you know flash loans and lending protocols you've seen that grow but once again that's mostly over collateralized yeah and so the crypto industry is going to need to find a way to finance liquidity and leverage you know more risk controlled fashion okay and I don't think the industry has quite figured that out yet okay just to come back to the actual collapse of 3C in the first place do you personally Trace much of that back to the collapse prior to three agencies of Terror and Luna in that ecosystem because that seemed to be a big factor you know um in a fund that large uh no single position should ever collapse an entire fund and so I think one of the things that I'm generally frustrated and as we look back on what went wrong in crypto you know a year ago or you know is folks trying to sort of hang everything on the Terra Luna blow up right you know it's like okay like this one currency blew up but it wasn't Bitcoin like it wasn't a big lunar investors though aren't they sure but it wasn't like you know I I highly doubt it was half their fund right you know or even a quarter of their fund yeah um and I don't know how much of their fund it was but if it was half their fund then you probably shouldn't be borrowing against a position in a relatively a liquid currency that's that big right so I do think that there's this whole thing where everybody wants an easy excuse and the easy excuse is Tara Luna blew up so all this other stuff blew up but I think really uh that's too easy and the reality is after the access of that market era we all needed to sit down and think about our risk controls think about our risk models and just think about how much we trust other Market participants and we needed to take a huge leap forward in how conservative the entire industry is and how Vigilant we are about protecting the health and safety of the market I think it does it like we're out of time but one last very quick question do you have any sense at all at this point in proceedings of where recoveries might come in in percentage terms or or even you know when you might start to see some recoveries happen I I don't have a view on that yet okay all right well the clock's at zero so hopefully we did okay in 15 minutes thank you very much Peter uh please give Peter a big hand everyone thanks very much thank you