The Breakdown - The Battle Around Three Arrows Capital

Episode Date: July 13, 2022

This episode is sponsored by Nexo.io, Chainalysis, FTX US and Ava Labs.   On today’s episode of “The Breakdown,” NLW looks at the latest in the battle involving toppled former crypto giant hedge fund Three Arrows Capital, including accusations from liquidators the fund’s founders were unresponsive, and accusations from Three Arrows that liquidators were causing harm to the fund by not exercising StarkWare warrants. NLW also gives the latest on Celsius, including why it’s covering its DeFi loans first.  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company safeguards your crypto by relying on five key fundamentals including real-time auditing and insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - Ava Labs releases Core, the free, non-custodial browser extension, built for the power of Avalanche. Core is an all-in-one operating system bringing together Avalanche apps, Subnets, bridges and NFTs in one seamless, high-performance experience. Eager to start using Web3 dapps to their fullest potential? Download today at core.app! - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsors is “The Now” by Aaron Sprinkle. Image credit: Michal Grosicki/EyeEm/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

This really is the dominant crypto narrative right now, the thing that is driving so many discussions in this space. It is the twin negative force alongside Fed tightening in the name of inflation fighting, which is driving crypto markets sideways and down. As you can probably tell just listening to this, it doesn't seem anywhere near resolved. And in fact, I would go so far as to say that it's not even resolved from a narrative perspective, say nothing of legal processes which can take much longer. Welcome back to The Breakdown. with me, NLW.

It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, chain aliasis, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, July 12th, and today we are catching up on everything that has been going on with three arrows, capital, and Celsius. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dig deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also, this week, I am very excited to have Avalabs as an additional sponsor.

Did you know that you can bridge Bitcoin natively across the Avalanche bridge and take advantage of the growing DFI ecosystem on Avalanche? This is just one of the innovative features of CORE, the new non-custodial browser extension and wallet developed by Avalabs. Core is engineered for Avalanche users to have the most secure and seamless Web3 experience. Easily swap assets, display your NFTs in style, and store your assets in a ledger-enabled wallet. Plus, you can put your real dollars in your Core wallet in just a few clicks. Go to Core.app to access the full power of Web3 on Avalanche.

Thanks again to Avalabs for sponsoring the show this week. And finally, my last note, in addition to them being a sponsor of the show, I also work with FTCX. So I mentioned it yesterday, but we are building up to the announcement of last month's inflation. This happens tomorrow and is the most significant event that will impact markets this week. The Fed is already building up expectations for it to be high, trying to get out ahead of it, and we're going to go all the way in on that tomorrow. But for today, we're going to focus on the crypto industry and specifically catch up on the big unwinds that have been dominating industry news.

In documents filed late on Friday in the bankruptcy court of the Southern District of New York, lawyers acting for the creditors of Three Arrow's Capital alleged that the funds founders, quote, have not yet begun to cooperate with the proceeding in any meaningful manner. The filing did say that people who were identified as Suu and Kyle were present on a preliminary Zoom call, but had their microphones and videos turned off and also didn't respond to any questions that were directed towards them. Instead, their lawyers took all their questions. Lawyers acting for the creditors that visited 3AC's Singapore headquarters found the office abandoned. This is something that Bloomberg seemed to validate when they posted a picture of mail piling up under 3A's door. The filing claims that lawyers for the founders believe that they have fled Singapore, stating, quote, the foreign representatives understand and believe that while the

debtor has had certain operations in Singapore, Mr. Davies and Mr. Zoo, current location remains unknown. They are rumored to have left Singapore. Lawyers for the creditors then fear that assets might be disposed of. For example, NFTs belonging to a subsidiary fund, Starry Knight, have been transferred without explanation already. Creditors then are seeking to freeze the fund's assets but are first asking the court to subpoena 3AC founders to produce a list of assets, including the wallets at controls, bank accounts, digital assets in its possessions, derivatives contracts, securities, accounts receivable, and all company records. In the wake of this, the court granted an emergency hearing which was scheduled for today, Tuesday, July 12th. Keep in mind, the founders of this company hadn't been

seen on Twitter since June 14th when Sue tweeted, we're in the process of communicating with relevant parties and fully committed to working this out. So after this latest announcement, everyone on Twitter was feeling different things. Some people were frankly just confused. Size Chad tweeted, what are Kyle and Sue's endgame? Others on Twitter were pissed. DC investors said, has there ever been a bigger, more years? universal fall from grace in crypto than 3A. Doquan worsened magnitude of losses, but a lot of people knew for a long time he was full of shit and that it would all collapse eventually.

Many thought 3AC were gods, or at least epic traders. Now, others have been pointing out that we aren't just talking about missing people here, but missing assets. Alex Venevich said the quintessential feature of crypto is that it cannot be seized. Are 3AC putting this to the test? Patrick Dugan went even farther, writing a whole speculative threat on this. He writes, The latest 3-AC drama wrinkle that Sue and Kyle are keeping somewhere between, let's say, 100 million and 300 million in assets and are gone fugitive with them, has got me thinking.

We live in a time where a rules-based world order is being challenged on all sides. Three-ero's capital is still a nine-figure operating hedge fund, with negative legal equity, but highly positive real asset value, assuming you don't GAF about the law. They are at the the mercy of friendly jurisdictions. Even with a yacht, still need to come in for refuel, can seize. Patrick then goes on to discuss the idea that Kyle and Sue could use these remaining nine figures of hard-to-sease assets to trade and earn off of dexes waiting around for the next bull run. He goes on, I don't think there will be a top three fund, but maybe top 20. Nine figures kind of puts you there by default. Plenty of seven-and-eight-figure funds, but not

that many nines. Can they arb effectively if they've burned all K-Y-C'd venues? Dex-to-de-de X-Arb is less profitable, or more. I expect Sue and Kyle to LP apps like Tornado, LP-No-Ky-C-Dexes, and if they're quite industrious, smurfed chains of little accounts with API rings to keep on arbing. In other words, stress tests the compliance aspects of the rest of the industry in perpetuity. Fraud charges? Why stop there? We've not yet had a scale actor who needed to lean on censorship resistance aspects of this industry yet. Compliance officers will tell their kids bedtime stories. And then the rogue, bankrupted hedge fund tried to smurf compliance, and our databases couldn't beat the Sibble attack. Now, this is all super speculative, as Patrick Well admits, but it is a relevant

thought experiment given the particular nature of this industry. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted partner by your side. Nexo is a security-first company that manages risk by relying on mechanisms such as over-collateralization, real-time auditing, and insurance on custodial assets. Learn more about Nexo's reliable business model and start your crypto journey at nexo.io. That's nexo.io. Eager to make more informed decisions around crypto, chainelysis is here to help. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigations support.

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The breakdown is sponsored by FTXUS. FtXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees no-ACH transaction fees and no withdrawal fees. One of the largest exchanges in the U.S.

FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees. Download the FTCS app today and use Referral Code Breakdown to support the show. Investor Adam Cochran wrote a thread taking us on a tour of the different type of assets at stake and how they might result in losses in the traditional finance world. He writes, 3AC contagion. Didn't think this was something I'd be discussing again so soon, but since this weekend's news broke that 3A wasn't, quote, cooperating with liquidators, it likely changes the timeline and severity of any force selling. If 3AC is indeed entirely uncooperative,

this could mean some liquid tokens they hold in EOA wallets can't be seized. Any tokens in custody or exchanges will be seized and liquidated. GBT allocations will be seized. Token allocations investing contracts could be seized. their class share funds, including defiance, will be in a fight for their life to try and not be liquidated. Depending on the existence of any agreements, projects that let them, quote, manage their treasury may have no path to be recognized in a liquidation process. A lot of this is bad. The liquidation of class share funds, the loss of treasuries, and force-selling likely OTC, of any vesting positions will really hurt the industry, especially during a bare market.

It could lead to a lot of young projects folding. But the big question is GBT, as we know they were a major owner of the product and that it can be easily seized. Adam then gets into a really long and interesting discussion of how the particular dynamics of the forced liquidation selling of grayscale Bitcoin trust shares could impact the spot price of Bitcoin as well as other institutional holders in the space. He concludes, ARC is likely to be the biggest public fund to take a hit here along with some Morgan Stanley funds. While its relatively small percentages, I think it likely has the impact of making mainstream funds more cautious around anything crypto in the future. I think in terms of tradfai impact, the losses of pension funds on Celsius, blockfi, etc., is likely a higher

impact. But it does mean there is a good chance that large market makers with cash on hand and risk appetite can likely squeeze retail on the spot price much further. It's also just one more arrow in the quiver of regulators looking for reasons to not approve further crypto products. So the hope is that enough people owed funds by 3AC will take on the in-kind transfers of GBT for potential upside and that local liquidation allows it. So again, as you can tell, we're all still in the realm of speculations and what ifs and what might happen and implications. But I do think it's occasionally important to try to stay up to speed on how people are looking at this, what the potential implications and fallouts are,

and how people are trying to prepare for that. However, then this morning, the day of the hearing, Sue himself popped back up on Twitter. After weeks of not posting, he posted two letters from lawyers acting on behalf of Three Arrow's Capital. These letters accuse lawyers acting for the liquidators of returning the matter to court without properly engaging with 3AC. They accuse them of releasing material to the media improperly, of failing to deliver a copy of the current application to 3AC's lawyers, of failing to exercise warrants that caused losses to 3AC. Now this particular question is really, really important. The specific asset in question were Starkware warrants and missing an execution option. As Hasu sums up, quote, it claims Starkware equity had a token warrant that

expired on July 5th. Liquidator didn't exercise the warrant, now Starkware tokens lost. This is obviously a potentially big deal, as that could have been an asset to help the proceedings. And that's why basically 3AC is now accusing the liquidators of acting in bad faith and with negligence regarding the exercise of the warrants. In a discussion featuring Hasu and many other people on crypto Twitter about exactly this, at Jack underscore Ted writes, liquidators have a legal duty to maximize returns for creditors of a business that is insolvent. technically it's a breach of their duties if they fail to take reasonable steps to protect and realize assets for the benefits of creditors. Mike Dutas, formerly of the Block now of Linksdao and Six-Man Ventures, says it's very possible they don't have a handle on all the assets and actions to take due to the disappearance of 3AC principles.

Jack again responds, agreed, depending on the complexity of operations and levels of cooperation from management, it may be very difficult for a liquidator to get a complete handle on the business so quickly. It's speculation, but the bait could even be the other way around. To which Charlie Sandor follows up even then, anyone looking at 3AC's portfolio would know Starkware was the crown jewel, with the latest round being valued at $8 billion. Pretty unexplainable for liquidators to drop the ball on one of the most valuable assets. Jack responds, yeah, it's speculation to call it either way, but it would be surprising if the liquidators had full and clear information

on the option to exercise and then elected not to. This is assuming the local territory laws permit a liquidator to undertake such a transaction. If your head is spinning with confusion, you are not alone, and the point that I want to make is this is messy and still very, very live and happening now. In terms of the hearing that happened today, the TLDR from Coin desk was that, quote, a federal U.S. bankruptcy court has approved a request by foreign representatives of liquidators of Three Arrows Capital to administer the crypto hedge fund's assets in the U.S. and subpoena its founders and other relevant parties. Moon Overlord, I think, sums it up best when he says, I can't even believe this 3AC stuff is really.

real? I think a common sentiment for sure, but it is not the only thing that's real. Another distressed institution, Celsius, has had an absolute blur of headlines regarding its attempt to stay solvent. In short, it appears that Celsius is attempting to repay as much as they can of their defy loans first in order to open up access to collateral that was locked up and to prevent that collateral from being seized as part of a bankruptcy process. Santiago Santos says Celsius paying off loans from defy protocols first. Smart contracts with program risk parameters can't be fooled like centralized lenders. In terms of the specifics, Celsius has paid down $95 million of its debt outstanding on

defy lending platforms AVE and compound. This repayment freed up about $172 million worth of Bitcoin collateral. Celsius took a similar action last week relating to outstanding loans with Maker, paying down loans and receiving $480 million in collateral. In total, Celsius has paid off around $300 million in defy loans this month. Now, it still owes $140 million to Ave and compound, and still has around $680 million in crypto assets pledged as collateral with those platforms. That was a lot of numbers, but like I said, I think it comes back roughly to what Santiago was saying. Defi loans don't care about bankruptcy

protection, so need to be dealt with first. How this is going to interplay with the traditional bankruptcy process is yet to be seen, and it's not necessarily clear yet that that's where Celsius is headed, or perhaps a better way to put it is that Celsius has to be. yet admitted that that's the path to which they're headed. Still, they have hired new restructuring lawyers. Siting sources familiar with the matter, the Wall Street Journal is reporting that Celsius has engaged Kirkland and Ellis to replace a different firm who were hired only last month. Notably, Kirkland and Ellis are also handling the Voyager bankruptcy restructuring and have reportedly advised Celsius on their options, including bankruptcy application. Celsius has not yet filed for

bankruptcy, but this change of legal representation may suggest that that's the strategy they're headed towards now. All right, guys, so that is the basics of what's happening right now in the contagion part of the crypto world. It is a lot, and it is not surprising to see people like Fed Governor Lail Brainer talking about these issues as an increasingly important part of the crypto regulatory conversation. We didn't even have a chance today to get into her recent speech about the crypto asset space, but many are reading it as a clear indication of how much defy is going to be in the hot seat

in the months to come. This really is the dominant crypto narrative right now, the thing that is driving so many discussions in this space. It is the twin negative force alongside Fed tightening in the name of inflation fighting, which is driving crypto markets sideways and down. As you can probably tell just listening to this, it doesn't seem anywhere near resolved. And in fact, I would go so far as to say that it's not even resolved from a narrative perspective, to say nothing of legal processes which can take much longer. What all of that means is that I continue to think that some of the best things you can do for yourself right now are remind yourself of the fundamentals of why you're here and what your

long-term beliefs are, and of course along the way, touch some grass, have a barbecue, and if even for a few minutes, turn off Twitter. For now, I want to say thanks again to my sponsors, nexus.i.o. Chainalysis, FTX, and Ava Labs. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.