The 3AC Demise with Kyle Davies

The 3AC Demise with Kyle Davies
Kyle Davies, co-founder of 3 Arrows Capital recounts the events which led up to the crypto hedge fund's demise and the aftermath.

Fresh out of the studio, Kyle Davies, co-founder of 3 Arrows Capital aka 3AC, joined us in a discussion to discuss their firm's demise in June 2022 and its aftermath after filing Chapter 15 bankruptcy. He explained why and how the firm's thesis on the crypto super cycle failed with the Luna-Terra collapse and offered his thoughts on the current meltdown of the crypto markets amid the ongoing meltdown. Last but not least, he offered his responses to several allegations and why he challenged the hosts of the "On the Brink" podcast on a debate about BlockFi and his perspectives on the current state of crypto post-FTX-collapse.

"What we did instead is we did not. The market rallied. We were just clouded in our judgment and we were not scaling the firm the way we should have. So that was probably one big one. The other one was after the liquidation I should have just had blinders on to the media and focused on creditors only and probably just had a round table and said these are what I think the options are. What do you think the options are? And if that were the case I think we probably wouldn't be in bankruptcy. We would've found one of the solutions that I just mentioned." - Kyle Davies (@KyleLDavies)
The interview in video format in Youtube


Bernard Leong: Welcome to Analyse Asia, the premier podcast dedicated to dissecting the pulse of business, technology, and media in Asia. I'm Bernard Leong and today's conversation totally deviates from my usual format. Joining me today from an undisclosed location, Kyle Davies (@KyleLDavies), co-founder of Three Arrows Capital [or 3AC in short]. Under normal circumstances, I would have him dig into his investment thesis, career highlights, and how he is helping the crypto ecosystem. But today we'll mostly focus on the demise of 3AC from Kyle’s point of view.

One quick disclaimer before we start— I am a web3 angel investor and a retail crypto trader. I do not have any business dealings with Zhu or Kyle from 3AC except that we had a couple of lunches together talking about other things other than crypto. I have my own opinions on the recent crypto crash and the players involved, but I will not be sharing any of my own perspectives today.

The aim is to let Kyle share his story from his perspective and let the audience decide for themselves where they stand. Of course, everything we discuss here does not constitute investment advice but is for informational purposes only. So do your own research. With that out of the way. Kyle, welcome to the show.

Kyle Davies: Thanks for having me. By the way, not undisclosed. I'm here in Bali.

Bernard Leong: To start, can you do a brief introduction of yourself and your background before you start 3 Arrows Capital with your co-founder, Zhu Su (@ZhuSu) together?

Kyle Davies: Sure. Zhu and I actually both started at Credit Swiss working on the equity derivatives trading desk. We were trading things like structured products, and convertible bonds and I stayed there for three years. Zhu moved to FlowTraders, which is an ETF, high-frequency trading shop.

Bernard Leong: I have Arthur Hayes’ essay “Number Three”  talks about how you both started in TradFi. How did you switch to crypto after arbitrage trading on foreign currencies?

Kyle Davies: Sure in many ways, the crypto market is very similar to the TradFi market. We looked at futures, forwards and spots. In other ways, it’s very different. If you look at the clearing model, and prime brokerage financing, these are completely different in it. We could actually spend about two hours going through this, but I'm sure you have some, other questions as well.

Bernard Leong: Maybe the easiest way to get in-depth into the question is actually to help my general audience of this podcast who may not be into cryptocurrency. Can you explain what market-making and margin trading are specifically in the context of crypto?

Kyle Davies: Sure. Market making, very simply [put], is providing liquidity such that when a buyer comes in, a genuine buyer, there may not be a genuine seller at the price that they want. A market maker will warehouse that risk for a period of time and wait until they find a genuine seller. Margin trading is the idea that you can borrow funds and trade beyond what you have deposited in a specific account.

The story of 3AC's Demise from Kyle's point of view

Bernard Leong: This is where I want to talk to you about what happened to Three Arrows Capital, but from your point of view, and discuss some of the recent events that have been happening in crypto as well, specifically about the FTX collapse.

The way I want to talk about the main subject of the day is to break the conversation into four parts. The first part is the investment thesis of Three Arrows and the trading before the Three Arrows Collapse, followed by the crypto crash with the immediate aftermath after the Terra Luna collapse, and then the filing of chapter 15 bankruptcy by 3AC. Lastly, I just want to get your perspectives on the current storm after the FTX collapse, depending on when we are publishing this podcast.

I understand that both Zhu and you have this crypto super-cycle thesis. Can you explain how you came to that thesis and how did it influence your hedge fund's trading strategies? [Reference: Zhu Su's tweet on getting wrong on the supercycle thesis]

Kyle Davies: So, the idea of a super cycle is that crypto is hitting mainstream adoption and it's somewhat analogous to, let's say the Web2 tech after the 2001 bubble where there's still volatility, there's still pullbacks but on, let's say a 30 to 40% pullback in the market. We would generally be a better buyer. I think that this is true to some extent, but the usage definitely is not keeping up. With some of the price action and furthermore from 2020 to 2022, there was really a massive credit bubble. I'm still bullish, but that's the idea.

Bernard Leong: How does it influence your hedge fund's trading strategies because you believed in this crypto supercycle? It does give you some idea of how you look at decentralized finance aka DeFi or NFTs [non-fungible tokens].

Kyle Davies: We invested in a broad array of ideas and innovation in the space, whether it was DeFi or various protocol scalability solutions or NFTs. I think there's a lot of interesting stuff going on. Generally speaking, the way it influenced trading is that we invested pretty continuously. We tried not to time the market per se, with an investment. We would just invest continuously through a cycle and with trading. Generally, on the 30 to 40% pullbacks, we were the better buyers.

Bernard Leong: You have done an NFT fund, Starry Night Fund with Vincent Van Dough and Defiance Capital for the DeFi piece of the trading as well.

Kyle Davies: That's right. We actually had several groups, so we had an OTC group that would focus more on the client-facing stuff. We had an arbitrage trading team that would look at the spreads. We had a venture-focused team and an NFT team as well.

Bernard Leong: So as you set up all this, you probably also have governance and risk management as well?

Kyle Davies Yes. So each group was run pretty independently, the idea being that if we wanted to invest in NFTs, let's say I had a broader thesis on it, but I was surely not the best person to do that, Vincent Van Dough, VVD was. He has probably one of the biggest NFT collections in the world.  The same goes for Defi with Arthur Cheong (@Arthur_0x). The same went for our client-facing business as well.

Bernard Leong: One of the highlights is the GBTC trade you made in the past and you may have made a huge profit if you had taken the money off the table in 2021 when the bitcoin prices were at an all-time high because GBTC was trading at a premium and then moved into a discount. After all, others were copying your trade. Matt Walsh (@MattWalshInBos) alleged the trade you made, given that you have told him not to publish it. That led to the speculation that you guys started to have problems when GBTC was trading at a discount and then turned to the Luna-Terra trade. Can you verify what happened then?

Kyle Davies: Sure. So we actually did very well off of GBTC [Grayscale Bitcoin Trust] and the [Grayscale] Ethereum Trust as well, ETHE. Those were relatively bear market trades. Those happened in 2019, 2020 & 2021. As we got bigger, we had to do a statutory filing for over 5%. As we are the largest holder of GBTC, we owned more than 5% of the trust. When we did that, the trust was still at a premium. So I was still okay to talk about it. That's because as you would subscribe, you would wait six months and then you'd be able to sell and harvest that premium. But when it went to a discount, I was very wary about talking about it. That's because as the largest holder, you're like a whale in the book. If you can decide to sell, [or if] you can decide to buy more, you can decide the timing of that. I just didn't want to give up any of my thought processes at that time, because if it leaked, the minnows would be front-running all of my trades, and that would've been Matt and Nick basically.

Bernard Leong: And so that's the reason why you didn't talk, you didn't want to talk about it and leave it as it is.

Kyle Davies: Yeah, exactly. So we did have a position, but I just thought given that the trust was at a discount and that the decision node wasn't as clear before, you would just sell it. You'd wait six months, you'd sell. But after there was a lot more game theory to it. I did not want to leak my hand.

Bernard Leong: And also that is also not the reason why you turn to the Luna territory. That's a separate thing, right? Because there

Kyle Davies Oh, the timing of that is like over a year different as well. By the way, that has almost nothing to do with it.

Bernard Leong: There have actually been a lot of red flags raised on Do Kwon's algorithmic stablecoin. Specifically, Kevin Zhou from Galois Capital (@Galois_Capital) explained why the stablecoin is actually getting more and more insolvent as it got bigger, I guess the question is not so much about why the trade was made, but I think the question to me is, you probably have read all the interviews out there, people raising red flags. Why did you both not pull out of that trade then, given that you have started to do a lot on the Terra/Luna USD ecosystem?

Kyle Davies: Yeah, good question. So I have a lot of respect for Kevin. Kevin's a smart guy. That said, there are a lot of other people on the other side of that as well, right? When we invested, we participated in the LFG [Luna Foundation Guard] round which raised a billion dollars. We did USD$200 million of that. So that means there were a lot of other people that participated: Jump, Delphi, to name a couple. The argument at the time was that the world needed a decentralized stablecoin. This was the biggest one. In general, scale matters. It was known to be unsustainable with the high anchor rate. So the main usage of UST the stablecoin itself was to deposit into anchor and earn 20%. But that wasn't the only thing that they built. They built lots of other usage for UST and as that rate would be lowered to a more sustainable rate, the usage of the other protocols would go up and that would be more sustainable over time.

Bernard Leong: What are the other things that were built that you mentioned here? Is it like, for example, Metaverse related stuff or NFT related?

Kyle Davies: It was across the board. Payments were a big one. But frankly, the idea was an entire ecosystem. There was gonna be no one specific thing. You asked what happened. What ended up happening is that after our LFG round, the team made the decision to diversify the reserves from just Luna to Bitcoin and some other coins as well. But the way they executed it was not amazing. So they gave a lot of UST to Genesis, which then immediately lent it or sold it to other firms, which in a relatively coordinated fashion, just sold it immediately.

The first question you asked [earlier] was, "What is a market maker?" A market maker's job is to hold a position and wait for a genuine buyer. There were genuine buyers. There was I was told 10 figures worth of buyers for UST. It was the best yield in the market at that time over at 20%. But that is not what happened. It was sold to immediate sellers who attacked UST and Luna at the same time, catalyzing the collapse.

Bernard Leong: And also the CURVE protocol was also upgraded.

Kyle Davies: Exactly.

Bernard: That led to the different actions and triggered everything.

Kyle Davies Exactly. Even after it was falling and UST had broken its peg, there were potential bailouts. There was a very serious offer from Binance as well as some others. And as we now know, with 20-20 vision, it would've been well worth it for everyone if it had been bailed out, right? I would've estimated at some point, it may cost USD2 billion to fix. That pales in comparison to the pain in the market that we feel today, right? But for worse it did not happen. Over time, this de-pegging cascaded and the cost would've gone up and it did not get bailed out.

Bernard Leong: That's the trigger of the death spiral and leads to Luna-Terra's collapse. That's a USD $54 billion ecosystem down to almost zero.

Kyle Davies In a matter of days

Bernard Leong: Galaxy Digital was also involved in that LFG round. There are quite a lot of big players involved at that point in time. I want to ask this question. Is there a world where this would have worked? Kevin Zhou would say that they shouldn't have jacked up the yield rates to 20%, because as they get larger and larger, more and more people investing equals the fund actually becoming more and more insolvent.

Kyle Davies: So it certainly should not have happened when it did. That was a product of the execution of the bitcoin trade [or BTC]. Whether it could have lasted a long time into the future is a better question for when the anchor rate was lowered, would the adoption that soaked up that USD have been sufficient to maintain the market capitalization? And I think we will almost never know, right? A decentralized stable coin is somewhat of a holy grail in crypto. While Bitcoin may be decentralized, Ethereum may be decentralized, censorship-resistant, and permissionless access. All the good stuff that crypto is, stablecoins are absolutely not. They have dollars in a bank account that are in an attack vector. So this is something that was an attempt at solving that and it failed.

Bernard Leong: If the Metaverse would have worked, they would have real economies. You can think of fiat currency as an algorithmic stablecoin except that there's a [gross domestic product] GDP, roads built, buildings built, and actual economies working and running. That's why algorithmic stablecoins in some sense should exist, but maybe it just doesn't have the economy ready from that point of view.

Kyle Davies: Perhaps I don't think it's the last time someone's gonna try.

Bernard: I totally agree. When the Terra Luna collapse happened, the death spiral happened. What was your reaction at that point in time from being an owner of a fund and also vested in the actual ecosystem itself?

Kyle Davies So, we didn't have any exposure to UST. We had exposure to Luna from the LFG round and for us, I was watching from the sidelines. I was not in the internal war room talking about the bailouts. I was maybe on the second or third rung of that and my reaction was that this really should have been bailed out. I thought about it then and I still think about it now. I thought the execution should have been handled in a better way. I think there was probably a coordinated attack as well as people had over the course of a year or more been shorting it, talking about the death spiral over and over again. They were wrong and they lost lots of money doing that. So I thought why? And, why this execution?

Bernard: So since you mentioned the bailout, how would the bailout work? That means a couple of exchanges maybe together with Binance FTX then and let's say we contribute 2 billion together to stop this whole thing from happening, but it still requires the Terra or the Luna governance to agree to it.

Kyle Davies: They could have just defended the peg, they could have just bought up to peg UST back to one.

Bernard Leong: I see.

Kyle Davies: The cost of that probably would've been around there. It depends on when they did it right. But...

Bernard Leong: So you think that they actually moved too slowly, that's the reason.

Kyle Davies: I think, they moved too slowly. There's also the prisoner's dilemma problem where you don't want to be the guy that does the bailout because you're bailing out everyone.

Bernard Leong: Okay.

Kyle Davies: So it goes.

Bernard Leong: Are there any other trades that contributed to the collapse of 3AC then?

Kyle Davies: Actually Luna itself was not devastating for us. We just lost what we put in the LFG round. What was painful was the aftermath. This was the first time that two top 10 crypto coins had gone to zero. Going to zero is very different than going down to 80%. Going to zero means you can buy things at 20 cents on the dollar and then still lose all your money, right? I think the hole in the market from that was enormous and the aftermath was too. Just to give you an idea, I think Bitcoin was down -Bitcoin, ETH, L1's (layer 1 blockchains) were down all 60, 70, and 80% each the credit market was freezing up. We had lots of recalls. We honoured all of them during that period.

All of our spread trades, like we did lots of finance, balance sheet kinds of trades, GBTC, as we mentioned, but also staked Ethereum and some others. At this period, the staked ETH broke its peg. All spreads blew out. The GBTC discount blew out. Everyone had similar trades and this was the catalyst, Luna.

Bernard Leong:  All the things that catalyzed and contributed to the collapse itself led to the 15 June 2022, although rumours have already started calculating into the press. When Su posted this tweet, “We are in the process of communicating with relevant parties and fully committed to working this out”.

Were you both working with the relevant parties then? And what were you are trying to do? Were you exploring other alternatives before filing for chapter 15 bankruptcy then?

Kyle Davies Yeah, absolutely. So there were parties that we were talking to about injecting capital. And it would've been better for everyone. Frankly, the chapter-15 bankruptcy means that it's a full liquidation process. That means I am no longer in control of the company and the liquidator is. If I look at what some of our colleague's firms did, we could have had a better outcome. Things like debt-to-equity conversion, an equity injection or even a debt token, some of our other firms did. The reality was during that period, it was very hard to have that conversation. The media was going nuts. There were all kinds of speculation running around and it didn't happen. So the creditors and we both filed for liquidation. They beat us by one day. Our firm is in liquidation with their choice of liquidator.

Bernard Leong: On those alternatives that you mentioned, I think they were only in discussion. They never got to fruition or even like close to, like maybe if we had pushed this button, it would have worked.

Kyle Davies: In retrospect probably all of them were options. I can look at other firms now... arguably are in worse shape that is not in bankruptcy. I'm still hopeful that there is a way we're talking to investors and we're talking to creditors, both about a new venture, but also about dealing with Three Arrows. I'm hopeful that there's a way.

Bernard Leong: Based on the aftermath of Three Arrow's filing of chapter 15 bankruptcy in early July, I think maybe personally, what have you learned and what would you have done differently?

Kyle Davies: There are several things, but if I go far enough back I would say in mid-2021, two of our early partners that were part of this, wanted to retire and we bought them out. They left. In retrospect, we should have fought to keep them or replaced them with multiple people each to fill partnerships. What we did instead is we did not. The market rallied. We felt we were just clouded in our judgment and, that we were not scaling the firm the way we should have. So that was probably one big one. The other one was after the liquidation, I should have just had blinders on to the media and focused on creditors only, and probably just had a round table and said these are what I think the options are. What do you think the options are? And if that were the case, I think we probably wouldn't be in bankruptcy. We would've found one of the solutions that I just mentioned.

Bernard Leong: What are your rebuttals to the different allegations made and general reporting by crypto Twitter and the mainstream media? What have they gotten wrong? What are the rebuttals to the allegations, for example, moving money to a shell company, and posting the same collateral to different lenders? What do you say to them? [References]: Here are the types of claims that the Analyse Asia editorial team referenced here: 1/ Claims that you have moved money out of 3AC into a company called Tai Ping Shan controlled by you both [Source: Forkast], 2/ Claims that you swindled $1m from an HK crypto fund [Source: Tech in Asia], 3/ Claims that you posted the same collateral to two different lenders [Source: On the Brink podcast by Matt Walsh and Nic Carter]

Kyle Davies: Let me address each one of those and then I can just talk more generally. The 1 million that was alleged to be moved was actually when our FTX account was liquidated. I believe it was moved from like a sub-account to the main account. FTX, I believe, settled that separately. So that was a completely false accusation.

The second [allegation was] that we had pledged collateral multiple times. It has been six months. I've never heard from the liquidator. I've only heard that it is alleged by two firms: I've heard it alleged by FTX who now we know did multiple collateral pledges and by the Castle Island guys with BlockFi [see reference podcast]. Both firms are in bankruptcy, legal action, regulatory [and] potential criminal [indictment]. So I have to believe that a lot of the media during that period was disingenuous and was not constructive in finding the truth. It was rather to put up smoke and mirrors or whatever. It was not productive.

I think I was thinking too much about what people were saying at that time. I really should have been thinking about creditors and just said-- closed-door meeting, we talk with creditors, we figure this out.

The third one, just for completeness, you said was moving money around.  The very last person who put money in overtime, actually we had a reduction of capital. Like after Luna, for example, we had some recalls. A lot of the major creditors recalled a third of their book or something like that. The last person who put money in was Zhu, so we very much believed in our thesis right to the end.

Bernard Leong: I think where we wanna get to is the Castle Island guys, because I listen to "On the Brink" podcast, even though I'm a fan, I want to be very fair here. So I think one of the things relating to BlockFi and based on your comments on Twitter.

We know that BlockFi has recently filed for chapter 11 for the second time after they thought that they were in the clear with FTX being the white knight. Then FTX collapsed as well. Matt Walsh and Nic Carter from the podcast created a bad boys segment for their podcast for Zhu Su and you. They play the [bad boys] music almost every week. Then you challenge them to debate on the podcast, which they subsequently refused even on neutral ground. They alleged that they don't debate with scammers. The heart of the debate, based on what I read from your tweets is, I think there were three things. One is about Nic Carter's pro-BlockFi argument on custodial Bitcoin or BTC. The other one is the USD$100 million settlement with the SEC in 2021, and then superior proprietary trading of GBTC with money on FTX.

What is the heart of your debate with them? What arguments would you want to lay out if that debate challenge was taken by them?

Kyle Davies Sure. So the reason [that] we have talked on Twitter with each other is that I just find them extremely disingenuous and hypocritical. At the same time, while they're like speculating on us, which I've just said are like completely false accusations, they're supporting BlockFi still to this day. BlockFi, just for full clarity here was masquerading around as a bank in the US. They had to settle with the SEC for that. Taking retail deposits, paying interest on them. And then were actually acting as a relatively risky hedge fund. They followed us into GBTC - lost half a billion dollars...

They fired their entire risk team and brought in someone new. Then they did some of the [most] riskiest lending. They just lent to two firms - us and Alameda Research, [and] maybe a couple of other small guys, eventually leaving all their funds on FTX. So Nic and Matt should really just look at themselves in the mirror and understand that they made an investment in BlockFi. They even put together an SPV for other investors in BlockFi and probably had their friends and others deposit [money] into BlockFI. That's unfortunate and sometimes we're wrong, but now we know that we're wrong. So at this point, I just find it absurd that they're so critical of us, without even speaking to us while still actively promoting BlockFi.

Bernard Leong: Let's say, the Bankless guys ask you to go on a debate with them and they agree.

Kyle Davies: I would happily debate with him. Yeah.

Bernard Leong: So you would just lay out exactly all the set of things that you talked about, for example, the whole thing about they are just like a crypto lender. They're doing all this proprietary trading. They're just acting like a hedge fund.

Kyle Davies: Yes, exactly. One of the unfortunate things in the space is sometimes people. They espouse the virtues of crypto, right? Sometimes you make a mistake, for example, investing in BlockFi. I invested in BlockFi early, and then as soon as GTC went on a negative basis, I sold it. For them it's unfortunate, but they're very much part of this Bitcoiner community - East coast Bitcoiner provincialism and somehow they got roped into the BlockFi scam and they're still promoting it. Guys, it was a scam. Get over it. That's the way the industry heals.

Bernard Leong: I think BlockFi is actually very similar to Celsius. I mean from the way I was looking at the company.

Based on your recent tweets on your creditors [Zhu Su’s tweets on the creditors and StarkWare token warrants and Kyle’s tweet on the creditors], what are the current issues with the creditors given you call the liquidators inaccurate, and what do you both want to achieve by going public on the record with them?

Kyle Davies: As I mentioned, I think we would've been best off if we never went into a full liquidation. Either we'd be in a judicial liquidation or we'd be in, not a bankruptcy at all. If we had been able to do that from the start, the reality is we're here now. It has been six months. Like these guys, the liquidators have paid themselves a lot of money. They've distributed zero to creditors and have done very little in the asset sense. So I think there is a better way. There are potential restructuring kinds of ideas and or ways we can involve people with a new venture as well. But these are all discussions that I'd like to just have with creditors, and I think it's beneficial to all.

Bernard Leong: But then what do you want to get if you just put it out in a public record? Is it just for negotiation or to set the record [straight]?

Kyle Davies: No, I'm reaching out to them directly. But every once in a while, there was a hearing. The liquidators put blame on us so that they can continue doing what they're doing. I feel sometimes that I need to put a rebuttal out there. There are other ways that you can sell the assets and you've been sitting on cash in a bank account for like months now. That's not distributed, right? Furthermore, you didn't listen to what we said with StarkWare. For me, if I join these hearings, I don't get a voice at all. Sometimes I can't even speak. I think that there's a better way forward.

Bernard Leong: So you hope that the creditors can directly talk to you and then try to tell the [liquidators]?

Kyle Davies: I am slowly making the rounds to speak to all of them. Then we'll set up a round table discussion so that we can see if we can find a meeting of the minds. At the end of the day. Right now, the liquidator is in control of the fiduciary duty to the creditors. So they have power if they can act together and if they have an alignment of interest. I have no power.

Bernard Leong: Okay, I hear you on that. That I will leave you to continue to work on and hopefully achieve a good outcome with your creditors. I want to switch subjects and really go into something else. Nothing to do with 3AC but is probably related in some ways. Haseeb Qureshi said on the chopping block podcast that you told him that you had figured out the methodology that Sam Bankman-Fried aka SBF was doing with FTX and Alameda when he met you in Singapore in June 2021, what is your recollection of that meeting? What did you say to him about Alameda, FTX, and SBF?

Kyle Davies: Yeah, absolutely. So this was right around the time of the Serum token launch. I listened to the episode with Haseeb, I thought he did a great job of explaining it, but I'll summarize it here. Basically, serum was the most predatory token to retail I have like ever seen. It was a very high fully diluted valuation. It had a very low float. It had a seven-year vest. It had a very high concentration in the team from FTX & Alameda Research. I thought that it was initially just going to be like the purest dump on retail, but it just didn't make sense because it was too obvious.

And after the launch, it traded up a lot. I think the round was around 10 cents. It was trading over a dollar, like on day one. At this point, I realized what it was and I just said that they must be buying. The reason they're buying is that it is cheap for them. They own a lot of it. The majority's all locked up. This was a time when they were hungry for credit, but lenders were hungry to lend out. If you had offered lenders like even unlocked Serum a year prior to that, they would've said no. They would've thought it was a joke. But at that time, they were just looking for excuses to lend out more. It might just make sense that they would even take locked Serum with a seven-year period, like zero liquidity on this stuff. And sure enough, that's exactly what happened. It was his cheapest form of financing.

Bernard Leong: I don’t know whether you have heard Matt Levine's [conversation] with SBF on Odd Lots podcast on yield farming during April 2022 where he talked about the magic box analogy.

Kyle Davies: I remember seeing the quote.

Bernard Leong: When Matt Levine called him out and said [paraphrasing] something along the lines of "aren't you running a Ponzi scheme on top of that?" Then SBF was trying to wiggle his way out. What he did with serum is the form of Ponzi [scheme] that you're talking about, where he was trying to get the highest amount of credit from retail investors with all these restrictive conditions.

Kyle Davies: I think so, and it was maybe in 2017 the Ponzies [Ponzi schemes] were very simplistic. What Sam realized is that he had a very large black box with Alameda, which was a pure black box. He owned, I think 90%. Gary owned like 10%. So that whole thing was a black box. But FTX was a black box to most people and also investors. He could put things in this box that would play with the knobs, right? So for him, the FTT token was the first time that he saw a token that he could post as collateral. This is where he got addicted to it. He probably regretted the way it was handled. He said he could have made a lot more money. He did this whole FTT thing wrong, and for Serum, I remembered hearing the pitch. The vision was a joke. The tech was more or less non-existent before they had just dreamed it up. If I had to speculate now, I would say the timing of that was probably because they needed to raise cash. It was not because that was the time of peak innovation for Serum. So I think Sam realized first with FTT that this was possible. Then he did it with Serum, Oxygen and, and numerous projects.

Bernard Leong: So you call the Ponzi Box scheme that they came up with, is basically the ICO 2.0 after 2017.

Kyle Davies Yeah they got more sophisticated. In ICO land you were supposed to sell. The founders sold. In 2021, the founders bought and borrowed dollars.

Bernard Leong: So you dealt with FTX before the Luna-Terra collapse, and you have also remarked you've tussled with them previously. What was the rate flex you noticed regarding SBF and his team at Alameda in deals with the crypto industry in general before they collapsed?

Kyle Davies: Yeah, sure. I met them relatively early when they were doing their high-interest loans. One of our partners had met them in Hong Kong and asked if I could meet the guy. I met him when he came to Singapore, and he walked out of a meeting on me. I was talking in a circle of people asking him. I had the deck and I asked him about the 15% guaranteed loans and "you can't lose money under US law". The AUM [assets under management] was very misleading. The profits part was very misleading. The whole deck was fraudulent on like multiple levels. And he walked out. And at that point, I knew that stuff was wrong, so I showed it to Zhu Su. We were pretty vocal. I think Zhu's done some tweets on this as well. But he raised FTT shortly thereafter. We now guess that this was probably to fill a hole. Probably he was using some money from one pocket to build an exchange on another pocket. So Sam had done this early on and over time, I didn't trade on the exchange for the first year and a half.

I thought it was a complete bucket shop. But then he started to get real investors: Temasek, being the most famous in Singapore, but also Ontario Teacher's Pension Plan fund, Sequoia Capital, Paradigm and some of the biggest, most respected VCs and institutions that are known for hard due diligence. I, as a user, cannot see the inner workings, but I thought perhaps they would. We eventually ended up trading on the exchange. There was a crackdown in China. I was the biggest open interest trader in Huobi and OKX. So when we moved that over, we needed a place to go and FTX was convenient.

Bernard Leong: And you all just thought that with all those like big VC funds, sovereign wealth funds, and pension teachers funds. So you all ended up also trading on FTX as a result.

Kyle Davies: We did, yeah, and we traded quite a bit there. I knew that there was some stuff that was probably not quite correct, but I didn't think that they would take client deposits. That's absurd. They spend client deposits and have them deposited directly into Alameda Research so that they then credit onto FTX. They hunt positions, print fake tokens and insider trade like these, which are all very serious. Any one of those can put you in jail in the US, right? So this was an offshore entity. Even still, this was really aggressive stuff. So I just thought given those institutions, there was no way he was going that far.

Bernard Leong: I think it's because the surprise was that the due diligence was not done very well. Temasek, as a Singaporean, is where my funds are in there. When they wrote out the actual memo about [why they screwed up], I thought that they were the only ones that owned up. I think Sequoia didn't own up at first and only after that, then they put on an apology to their LPs because of a leak in The Information. I was actually very surprised by not enough amount of due diligence. Did any of those due diligence people just call you up and say, "Hey Kyle you guys run 3AC, what do you think of FTX?"

Kyle Davies: I can't recall from any of those specific investors, but pretty much anyone that asks. I was very vocal about FTX in the early days and I was told I was an idiot many times because FTT was a huge success for a lot of people. I knew many people that turned seven into nine figures by investing in FTT. The same goes for Serum. So I was repeatedly reminded that I was the wrong one. But this is the way it goes and, frankly, I don't blame any of these investors for their messaging to others. At the end of the day, early-stage investment sometimes succeeds and sometimes fails.

I think if I were in Temasek and maybe reviewing things, I would probably just say, you know what, we're still gonna do investments in early-stage stuff. But we're just maybe not gonna do it in our name anymore. We're gonna invest in other funds that do it. Or, maybe create some-- which, they already do.

But this one was just particularly painful because it was done so publicly by such a big name. Whether you like it or not, people are going to take that as a stamp of approval.

Bernard Leong: There was one thing that happened during the New York Times interview, that SBF said which actually reveals what he thinks about VCs cynically and he said that they only trade on the upside and they forgot, they always never think about the downside. Maybe that was how he managed to get them to put the money in. But I want to get your point of view on this. So based on the FTX collapse,  you have also alluded to that as well. It has been alleged that SBF had committed fraud by commingling funds between Alameda Research and FTX. What are your thoughts on the FTX collapse and his recent media tour? He also went to the Block with Frank Chaparro as well, who tried to grill SBF for two hours.

Kyle Davies: I watched that one. He also did one with the Wall Street Journal, Good Morning America, and many others. I think that he has done enormous damage and been incredibly fraudulent in many different ways. So it's not a case of misleading investors or something. His media blitz surely is just to show ignorance over negligence. We'll see if it works out for him, but it's just very hard to believe this stuff.

Bernard Leong: Based on what has been alleged, do you think that Sam should go to jail if all the allegations are ever proven true?

Kyle Davies: Yes. I definitely think he should, but it's really gonna come down to first, jurisdiction and second, his dealings in the US. There are numerous regulators in the US. I'm sure he's violated some stuff in there.

Bernard Leong: If I want to flip it over to the Terra Luna collapse, which you [3AC] lost money. What should we do about Do Kwon? Should he be punished?

Kyle Davies: That is a much more difficult question in my mind. Because at the end of the day, Do Kwon designed a technology platform and it failed. So whether it is criminal, is a question of whether he intended to fail. Did he know that it would? Did he profit from it? If those questions are all, no, then maybe this is not. But if a judge determines that some of them are yes, and there was malevolent intent, then maybe.

Bernard Leong: That will be decided by Korean law because they are the ones going after him now anyway.

Kyle Davies: Right, which is another question of jurisdiction as well. Yeah, this is one of the tricky things about crypto.

Bernard Leong: There's not much regulation on that. But I think now that everyone has gone through this part of history. Actually, to be quite honest, it's very similar to what happened to gold in the 1890s when you know there was Jay Gould causing a bank run. For all the market makers [at that time], the railway is the equivalent of today's technology and everything else. Maybe the question I want to ask you is: should crypto be regulated after this debacle? How should we think about risk management and governance?

Kyle Davies: So I will say that US regulation pushed FTX offshore, and the lack of enforcement allowed BlockFi to keep operating after getting a hundred million dollar fine from the SEC. Luna is largely not in the US. So the question is going to be what regulation in what jurisdiction, and I don't have a good answer for that. That's up to other people to decide.

Bernard Leong: Do you think that like things like stablecoins needs to be regulated? For example, there's a stablecoin bill that was supposed to be for the collateralized or over-collateralized stable coins are okay, but algorithmic stablecoins shouldn't be allowed or something along those lines.

Kyle Davies: I think in general that if you regulate the previous cycle, the market has already learned, right? Crypto in many ways is a capitalist libertarian future, and if you are allowed to play these large experiments and they blow up, then they don't happen anymore, right? People will try new things. So if we try to regulate exactly what happened the last cycle, it likely will have no bearing on what happens next cycle. That's where the problem in this regulation is going to be.

Bernard Leong: I think one problem with crypto or Web3 we call it, is that whatever you do, there's always an embedded capital market that sits on it. It doesn't matter what you do, and I think that is where the challenge really is. Once you have an embedded capital market, you can throw any form of financial engineering at it. Let me ask, are you or Zhu Su still bullish on the space and believe that a supercycle will still come someday?

Kyle Davies: We are still bullish on the space. I think the aftermath of FTX has not been felt entirely yet. The reality is it's gonna take six months. To really know the full implications of that, we'll start to see some form of regulation to come through too. But really, it's the insolvencies, the companies, the projects that run out of money, because it'll be hard to raise in this environment. All that stuff needs to flush first. Then after that, we can go super cycling again.

Bernard Leong: The question is actually all pending due to whether Genesis will be insolvent and take down the entire [Digital Currency Group] DCG, because that's the only near-extinction event that's going to happen.

Kyle Davies: They're not the only ones. I'm not going to name them on the show, but I could name numerous firms, which are likely insolvent and struggling.

Bernard Leong: No, I think that there is this interesting point of view. Actually, when I met you both, I actually went and drew a map of all the relationships of the lending firms, the hedge funds and everything, I discovered that everything leads to Genesis. The question is that if Genesis blows up, then everyone blows up as well. The real near-extinction event is probably if Tether gets de-pegged and causes a bank run on Binance.

Kyle Davies: Arguably Bitcoin should be nuclear proof, but in terms of even more serious damage to the industry, there has been a massive consolidation; I would argue that has never been seen since this potential level of consolidation in the stablecoin space and in the exchange space, and probably also now in the DCG.

The whole point of crypto in general is that there's decentralization and choice. This prevents attack vectors. Now we have three or likely more prominent firms which have their own risk mitigants or whatever but it's just that each one of those has an >80% market share in their dominant areas. That's not the way crypto's supposed to work.

Bernard Leong: If I read you correctly, what you're saying is that it's better to be decentralized, so there's one. That means-- you will look at something like Bitcoin because I, was listening to different podcasts. Everybody thinks that you're now all into Bitcoin and not into the other coins.

Kyle Davies: No, I was. I've been very jaded through this process. I started with Bitcoin and I liked the principles of bitcoin and the sovereign individual. These whole ideas are guiding principles for the space. I do think that there can be other investments and other ideas. But I think it's worth now taking a harder look at some of them. During certain periods, maybe you let the innovation go. Now I think it's worth taking a good hard look and saying why we have this giant consolidation in these areas. Why did the lending space have this giant credit bubble? What do we think about that?

Bernard Leong: That is very fair. So I probably have two more questions, but I think the first question I want to ask is: is there anything you want to say to your LPs? Creditors. Investors, investees. Friends, families and employees after this event. I'm sure it was not very easy on you and plus all the things that are going over the world, the media, and I think I hear some of the tussles you have and some of the things that people were saying about you. Is there anything you wanna say to them?

Kyle Davies: I know there's a lot of pain and we lost all of our money in the fund. I know investors, creditors family, and friends also lost lots of money. All I can say is we'll do what we can.

Bernard Leong: And you're sorry about it. I'm just, I just wanna make sure that I...

Kyle Davies: Yeah, I wish things could have happened in a different way, but at this point, we're gonna do what we can.

Bernard Leong: Okay. One last question would be, what are both of your plans for the future, of course, after all of these issues and turmoil, and maybe the issues with the creditors & liquidators have been resolved?

Kyle Davies: So we're speaking with investors and soon creditors as well about a next venture. I think this is just the best way forward. The liquidation process will run. I think there are better ways that we can probably do it. But ultimately that will be up to the creditors.

And in terms of a new venture, would like to include people to the extent that it makes sense. And I think this is the best.

Bernard Leong: The thing about these things is trust. Do you believe that they will trust you again?

Kyle Davies: So for creditors, I think we can include them in whether they can invest or not invest. We can probably still include them. For new investors, yeah. It's not a question.

Bernard Leong: Okay. Kyle many thanks for coming on the Analyse Asia podcast I wish under better circumstances that I would like to have lunch with you and Zhu, and discuss other things other than crypto. In closing, I have two very quick questions. During this time, do you have any recommendations which have inspired you recently through such dark times?

Kyle Davies: Yeah. So for me, June and July were my darkest months, and I know that other people are maybe having their darkest months now. What I can say is that nothing lasts forever. The good times, the bad times, nothing lasts if you're feeling that way. What helped me was first focusing on myself, self-meditation, no alcohol, no medication. Then family and then rebuilding outwards. I believe you can see the light.

Bernard Leong: How can my audience find you?

Kyle Davies: Twitter is probably the best one for now. Zhu and I both have accounts. But maybe we can be a little bit more public in the future.

Bernard Leong: And of course, you can definitely find us at Analyse Asia or tweet us and give us your feedback. We are definitely distributed across all platforms. So Kyle, many thanks for coming to the show. Take care, Zhu Su and yourself and I look forward to better times when we can speak again.

Kyle Davies: Thank you.

Podcast Information: The show is hosted and produced by Bernard Leong (@bernardleong, Linkedin) and Carol Yin (@CarolYujiaYin, LinkedIn). Sound credits for the intro and end music: "Energetic Sports Drive" and the episode is mixed & edited for both audio and video formats by G.Thomas Craig (@gthomascraig, LinkedIn). For the first time, we have this episode recorded in video format.