American hedge fund geniuses of the cryptosphere have failed | Mint – Mint

Cryptocurrencies were supposed to teach traditional financiers a thing or two about how to avoid collapses and crises. Yet, it feels like were simply repeating history. Specifically, the messy hedge-fund humiliation captured in Roger Lowensteins 2000-published book, When Genius Failed: The Rise and Fall of Long-Term Capital Management.

After Terra and Lunas $60 billion stablecoin collapse and the freeze of withdrawals at crypto-lending platform Celsius, trading firm Three Arrows Capital now appears to be in trouble. The fund is liquidating its holdings amid fast plummeting prices, and an ominous tweet from co-founder Zhu Su about communicating with relevant parties" is stirring fears of something potentially more fatal.

A glance at Three Arrowss past crypto betson the likes of Luna and Axie Infinity, as well as Bitcoin and Etherleaves very little doubt that the communicating" is probably not of the fun kind. The fund, estimated to be managing $10 billion in assets in March, combined Zhus derivatives expertise with a kind of beatific conviction in a broad crypto supercycle", which he recently admitted was wrong.

That waves of forced selling still seem to be rippling through crypto markets shows how complex and lending-driven this market has become. Traditional finances margin calls take on a more brutal form in the cryptosphere when smart contracts automatically liquidate positions in quick succession. The current focus is on Three Arrowss exposure to staked Ether, a token designed to earn interest while Ethereum upgrades its network, which has been buckling under heavy selling pressure.

But it also suggests lessons from history have been ignored. This is hardly the first boom-and-bust cycle in Bitcoin or the broader crypto market; this years 65% drop in the Bloomberg Galaxy Crypto Index is similar to the crash seen back in early 2018. Yet, hedge funds set up to deliver market-beating returns from crypto assets look blindsided. Average estimated returns for those providing daily data were -24% in April, -32% in May and -28% in June, according to industry database NilssonHedge. A large number of managers have simply stopped trading", it says, with the total tracked falling to 325 from 510 in January.

The risk of a generalized crypto slump, the kind that humbled token-picking strategies in 2018, doesnt seem to have been high on their radar. The kind of strategies designed to exploit inefficiencies between exchanges that might bring in 6%-10% returns have been juiced by funds using DeFi lending platforms offering lucrative rateswhich are proving unsustainable. As one hedge funder tells me, its like picking up BMWs rather than pennies in front of a steam-roller. The end result still involves getting squished.

With more than 40% of crypto funds using borrowing and lending strategies, according to PwC, the current turmoil feels like a rug-pull rather than vindication of trading smarts. The winners are probably those that simply got their money out in good time. Two-thirds of crypto funds are likely to fail, reckons Mike Novogratz. Short-sellers seem to be in short supply.

Three Arrowss Zhu perhaps spoke for many investors earlier this year when he said the lesson of 2018s slide was to stay bullish and not give in to despair." Hence his praise for all sorts of clearly speculative shenanigans like Axie Infinity, a crypto game that pays people who spend their days breeding virtual pets thats been battered by deflating hype and a $620 million hack. His justifications seemed wrapped in futurism rather than risk management: His bible" James Dale Davidsons 1997 book The Sovereign Individual, foresaw some of the social upheaval of the internet age.

Maybe Zhu should have been reading When Genius Failed. As Novogratz has observed, whats happening in crypto echoes the 1998 blowup of Long-Term Capital Management, a hedge fund stuffed with very smart people, including a pair of Nobel laureates,dealing in sophisticated arbitrage strategies juiced by derivatives. When the unthinkable happened and losses piled up, banks called in their loans and eventually took over the firm.

The silver lining is that there seems to have been little bank involvement in the crypto slump. This is probably just as well, given the risks of contagion spreading to a real US economy already battered by rising inflation and weak economic growth.

But that doesnt change the fact that real losses are being racked up by funds and punters who are least able to afford it. Whatever happens to Three Arrows, the lesson of 2022that crypto prices can go down and can keep going down for months on endshouldnt be forgotten the way 2018 was. bloomberg

Lionel Laurent is a Bloomberg Opinion columnist covering digital currencies, the European Union and France.

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American hedge fund geniuses of the cryptosphere have failed | Mint - Mint