Contagion risk from Three Arrows Capital weighs on Bitcoin, crypto

Reports suggesting an increasing likelihood of Three Arrows Capital Ltd. (3AC) facing an insolvency weighed on the broader cryptocurrency market Friday, reversing most of the gains made in the wake of the Federal Reserve’s guidance on rates.   

Over the past 24 hours, Bitcoin was down 0.9% to US$20,958.73 and Ethereum fell 1.5% to US$1,096.53, according to CoinGecko. The carnage that began last Friday after U.S. 12-month inflation came in at a 40-year high, has led to the prices of the world’s top two cryptocurrencies falling by nearly 30% and more than 38% respectively.

The global crypto market capitalization was down 1.4% to US$941 billion, still below the US$1 trillion mark that it had been above since January 2021. Over in stablecoins, Tether’s USDT market capitalization was down to US$69.41 billion, at levels last seen in October last year.

U.S.-based crypto lender BlockFi was among Three Arrows Capital’s lenders that liquidated at least some of the crypto hedge fund’s positions, the Financial Times reported on Friday. Three Arrows is among the world’s most influential crypto hedge funds.

The fund had borrowed Bitcoin from BlockFi but was unable to meet a margin call, the newspaper said citing people familiar with the matter. One of the people told the FT that the liquidation had occurred by mutual consent. BlockFi founder and chief executive officer (CEO) Zac Prince said that the company has foreclosed on “a large client that failed to meet its obligations.”

See related article: BlockFi among those that foreclosed on Three Arrows Capital: report

Staying within your means

As with stock markets and other asset classes, it is fairly common for hedge funds to borrow and take positions or “leverage.” This helps them with amplifying relatively small returns due to the scale of their positions. But those positions can quickly unravel when prices move steeply, triggering margin calls from lenders.

The implosion of Archegos Capital Management in March 2021 had ripple effects across global financial markets, causing investment banks and others to lose tens of billions of dollars. The hedge fund, founded by Sung Kook Hwang, better known as Bill Hwang, reportedly lost some US$8 billion in 10 days, a person familiar with the matter told The Wall Street Journal. 

For the crypto world, Three Arrows’s troubles come in close proximation to Celsius Network’s freezing of withdrawals as its decentralized finance (DeFi) strategies failed. The interest-earning yield platform reportedly suffered a series of severe losses including over 38,000 ETH in a blunder related to Stakehound, followed by a US$22 million loss in connection with the Badger DAO hack.

See related article: Celsius said to be hiring restructuring attorneys, exploring financing options

“Obviously the news happening with Celsius and 3AC only strengthens all this negative news,” Manuel Jaeger, cofounder and head of crypto at Singapore-based digital securities platform ADDX, told Forkast. “We are experiencing very uncertain times,” he said.

This comes as about US$211 million worth of cryptocurrencies were liquidated in the last 24 hours, with the number surging to US$1.15 billion on June 13, according to CoinGlass. 

“I think this is an example of crypto hedge funds not considering the macro environment with their outlook for crypto in the medium term,” Marcus Sotiriou, an analyst at the U.K.-based digital asset broker GlobalBlock said. “This is shown by one of the biggest crypto hedge funds Three Arrows Capital taking on substantial margin, which they are now potentially unable to repay.” 

Some crypto enthusiasts have increasingly demonstrated a tendency to not follow macroeconomic trends.

Speaking on a UpOnly podcast in February 2021, Three Arrows cofounder Su Zhu said Bitcoin’s price could go as high as US$2.5 million per coin if it were to capture the same market value as gold.

But it was only in May, Zhu admitted that his “Supercycle” price thesis was wrong, referring to his idea that the crypto market would gradually rise during this market cycle, avoiding a sustained bear market. 

“You need to look at it from an overall macro environment,” Jaeger said. “The inflation, the war, the pandemic and all of that I think is leading to the current bear or crypto winter that we are seeing.”

“I think the biggest concern is that there’s going to be a contagion risk,” Jaeger said. “That means that what’s happening now to Celsius and Three Arrows Capital might spread to other players…key players in the market or potentially worse to the overall financial system,” he added.

“I think the biggest concern is that there’s going to be a contagion risk.”

– Manuel Jaeger, ADDX

“Regulation is needed in my opinion to stop the drastic impacts of human greed on the crypto markets,” GlobalBlock’s Sotiriou said. “I am looking forward to clearer regulation attracting more institutions from traditional finance into the space.”

See related article: Has ‘Crypto Winter’ arrived with Bitcoin, Ether prices falling?

Ben Caselin, vice president of global marketing and communication at crypto exchange AAX struck a sanguine note. 

“It doesn’t mean everything will die,” Caselin said. “It just means that the things that don’t stand up to the standards may not be very fortunate in the future.”