Three Arrows Capital and Celsius: Battling against insolvency

Playtime is over!

It all started in January 2022 when the DeFi ecosystem faced the brunt of the bears fueled by sinking rumors of Three Arrow Capital (3AC) and Celsius liquidations. MakerDAO decided to disconnect Aave (AAVE) from its direct deposit module as protection in light of the possibility that Celsius folds and crashes the Staked Ether (stETH) price. The top 100 DeFi tokens were hit strongly by bears, with most tokens registering multi-month low and double-digit losses.

Su Zhu, the co-founder of Singapore-based crypto venture capital firm Three Arrows Capital (3AC), has posted a cryptic statement on Twitter in response to the circulating rumors that the company is battling against insolvency.

Online chatter about 3AC being unable to meet a margin call began after 3AC started moving assets to top-up funds on decentralized finance platforms such as Aave to avoid potential liquidations amid the tanking price of Ether (ETH). There are reports that 3AC faced liquidations totaling hundreds of millions from multiple positions.

Danny Yuan, CEO of trading firm 8 Blocks Capital, called out to platforms holding funds owned by 3AC to freeze the assets as rumors of 3AC’s insolvency stay afloat.

In a Twitter thread, Yuan explained their company’s involvement with 3AC, noting that they are paying the company to use the trading accounts that they own. The agreement included the ability to withdraw funds at any given time.

Five months later, Three Arrows Capital (3AC) was liquidating its positions after witnessing huge losses on its investments.

An analysis by Messari.io of 27 assets that 3AC had invested in suggests the crypto hedge fund would have lost 60% of its investment for the year. The assets included lead cryptos such as Bitcoin (BTC), Ethereum (ETH), and Avalanche (AVAX).

It has resulted in a subsidiary of Voyager Digital, the US-based cryptocurrency platform, stating it may issue a default notice to 3AC if the crypto hedge fund fails to repay its loans.

Reuters reports that Voyager said it loaned to 3AC 15,250 BTC, which is just over $310m and $350m Coin (USDC).

Initially, Voyager asked 3AC to repay $25m (£20m) in USDC by 24 June and then requested the entire amount to be repaid by 27 June, but Voyager has not received payment thus far.

Voyager is also discussing what legal action it could take to recover the funds from 3AC.

In addition to the 27 assets identified by Messari.io, the Twitter account for The Defi Edge reported 3AC had also spent $559.6m buying locked LUNA before the cryptocurrency’s collapse last month. “It’s now worth roughly ~$670,” added The Defi Edge.

And Danny Yuan, head of trading at crypto trading firm and liquidity provider 8BlockCapital, suggested Three Arrows Capital was “leveraged long everywhere.”

The fund was also reportedly starting to consolidate its NFT holdings in a possible attempt to sell them and cover its losses. Last year, it amassed an extensive collection of non-fungible tokens (NFTs), such as ones from the Fidenza and Ringers NFT collections. It secured A Poetic Beach by the Chinese digital artist Dabeiyuzhou at Sotheby‘s with a $140,000 bid.

In the run-up to Wednesday, 15 June, the 3AC NFT fund, Starry Night Capital, had reportedly moved its entire collection from the NFT platform SuperRare – a total of 70 NFTs 3AC had spent more than $21m building up since August last year. STRANGE RIGHT?

Furthermore, 3AC allegedly tried to pitch a GBTC arbitrage trade to many big-name investors a few days before the company’s rumored collapse.

3AC co-founder Kyle Davies did disclose to the Wall Street Journal that the Terra LUNA and UST (USTC) fallout hurt the company, and plans were being made to find an “equitable solution” for all of 3AC’s constituents, but we will see.

Let’s now look at the other participant in the subsequent cryptocurrency saga.

Worries around Celsius have been circulating for some time, but recent investigations of the firm’s active positions amid a struggling market began to ring alarm bells.

Of particular concern are the large amounts of staked ETH held by Celsius (~$500M of which was pulled out of Anchor Protocol) and the liquidity crisis this creates.

While the 288k ETH that Celsius has staked directly into the Eth2 Deposit Contract isn’t redeemable until after the mainnet merge, wrapped stETH can be traded freely.

However, the only substantial on-chain liquidity for stETH is ~125k of ETH in the Curve pool, which has already become heavily unbalanced. ETH currently commands a premium of ~5% over its staked counterpart, over a year’s staking yield.

And having ETH locked up isn’t their only problem. Celsius also has 18k WBTC ($420M) in MakerDAO at risk of liquidation if BTC continues to tank.

As well as their current positions, Celsius has lost a total of $120M over the last year: ~$70M in StakeHound-wrapped ETH and another $50M in the BadgerDAO hack.

To process mass retail withdrawals, Celsius needs liquid assets quickly.

Celsius is left with two options; either further borrowing against precarious and illiquid collateral, which could lead to liquidations, or borrowing from elsewhere to increase their collateral.

But now everyone knows that Celsius is in trouble, so potential lenders will not be acting charitably as they position themselves to profit from Celsius’ desperation.

Even if Celsius is a long-term solvent, banking on them until after the merge, when their staked ETH becomes liquid, is too much of a risk right now for those who can afford to take it.

However, CeFi competitor Nexo did “reach out” to offer an acquisition deal, which was promptly refused.

CeFi going full degen with user funds will be used as a way to further demonize DeFi by those that don’t approve of financial autonomy.

However, the transparency inherent with DeFi protocols would have prevented Celsius from hiding their activities and allowed users to exit before it was too late, despite Celsius ignorantly claiming otherwise in the past.

The general public, however, will not make that distinction, as they will be distracted by the crashing prices and tragic stories of misled investors, which will circulate for the second time in as many months.

While Celsius may have triggered this crash, and Luna the one before it, it’s clear that crypto-mania has remained unsustainable for too long.

Now, playtime is over, and the markets will purge the unsustainable schemes we have accumulated over the past two years.