Rough tl;dr of 3AC situation, for tradfi folks interested
- 3AC is a >$10bil crypto hedge fund
- Borrowed money from a bunch of ppl to lever up a bunch of crypto-assets
- Crypto assets went down
- 3AC probably went bust
- Some ppl who lent to 3AC might also be in trouble
Conversation
Leverage is simple: if 3AC wants to buy $10bil of BTC with 5x leverage, they could borrow $8bil of money from someone, and put $2bil of their own money in. If BTC goes up 20%, so the position is worth $12bil, 3AC makes $2bil and doubles their initial investment! 3AC is happy
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Of course, this works both ways. If BTC drops 20%, so the position is worth $8bil, then 3AC loses its entire $2bil. Leverage increases your upside and your downside
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Now the problem is, what happens when BTC loses _more_ than 20%, say 40%? So 3AC loses more than the entire amount of money they put in! Then whoever lent $8bil to 3AC is kind of screwed, as 3AC not only lost all their money, they only have $6bil of BTC to pay back the debt
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Normally lenders try not to let this happen, by monitoring the price of the BTC 3AC buys, and thus the value of 3AC's levered position, and require 3AC to give them more money as "security" if it looks like the BTC value is crashing
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For example, suppose BTC price crashes to $8.5bil on a $8bil loan. Lender might be worried that if the price crashes further, they will lose money. So they'll require 3AC to pay back some of their debts, say so that they borrow only $6bil on $8bil. This is a "margin call"
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So suppose BTC price crashes to $8.5bil, lender margin calls 3AC and asks for money. There's a few possibilities:
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1. 3AC pays down debt to $6bil, we gucci
2. 3AC refuses to pay down debt. Lender takes 3AC's BTC, sells it, gets the $8bil that they're owed, and gives 3AC the rest
3. 3AC refuses to pay down debt. Lender is like "oh things will maybe be OK" and lets 3AC run with it a bit longer
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Now the reason why 3AC's blowing up can affect market conditions more broadly is because of how cases 2. and 3. work.
In case 2., to get back their debt, the lender is going to take a giant pile of 3AC's BTC and try to sell it on the market all at once
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When you sell stuff, the price goes down. Why this is bad is, other than 3AC, there's probably a bunch of other people also yolo-long BTC with leverage. As the price goes down, their lenders margin call them, take their BTC and sell it... and so on, in a giant fire sale doom loop
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So as one levered long unwinds, that can drive prices down, forcing others to unwind, and causing a giant drop in prices. (Not necc 100% due to this, but) check out these price charts... BTC and ETH each dropped like 30% in a few days
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So one bad thing about yolo-levered-long hedge funds unwinding is that they can create these "fire sale doom loops" which drive prices to drop very quickly
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What is worse, though, is 3., if the lender isn't able to sell the collateral, 3AC is able to hold the BTC until it's worth like $6bil, and the lender is out $2bil. Why is this so bad? Why should we care if some group lending to a yolo fund loses money?
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Issue is that often, in tradfi and defi, a surprisingly big set of parties lend to yolo funds, and many of these parties also do other things in the economy. Big banks (Goldman, JP Morgan, etc) do a bunch of lending to hedge funds, and lose money when e.g. Archegos blows up
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The scary thing in defi at the moment is:
- A bunch of people probably lent money to 3AC, and many of them are probably going to lose some of it (exchanges, "defi savings" entities... etc.)
- We don't really have a great idea _who exactly_ lent money to 3AC at the moment
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So... at the moment people are waiting to see who lent money to 3AC, and whether anyone else might blow up as a result
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Disclaimers:
- Numbers in the example are 100% fictional
- I don't know the 3AC guys and don't have credible inside information from primary sources
- "Fog of war", hard to get any good data, pretty much everyone is speculating atm
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