Three Arrows Capital Founder Talks About His New Crypto Bankruptcy Exchange

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Less than a year after Three Arrows Capital (3AC) implosed with $2.5 billion in client money, hedge fund founders Su Zhu and Kyle Davies are back with a new crypto exchange -currency where people can trade bankruptcy claims – a hot area given all the distress in the industry.

THE Open Exchange (OPNX) was announced last month, garnering wry smiles and smirks. The crypto community hasn’t always been so skeptical of the duo. Until the collapse of the $60 billion Terra ecosystem last April, they were hailed as messiahs among their peers, touted for running the hottest hedge fund, and often endorsed by trading companies and investors. market makers.

It ended bitterly when the market fell last year. The company’s long-term trading strategy quickly played out in a pool of bad debts and unsecured loans before ending in a period of contagion that hit a series of top crypto firms. (This includes Genesiswhich has the same parent company – Digital Currency Group – as CoinDesk.)

Zhu and Davies attempted to escape the heat by traveling to Singapore. Zhu sold his real estate in Singapore, while a $50 million, 500 tonne superyacht dubbed ‘Much Wow’ was repossessed after the couple failed to meet monthly payments.

After months of relative silence, Davies appeared on CNBC in November. Davies revealed that he lives in Bali, one of seven countries that do not have an extradition treaty with the United States. After that toasting, Davies retreated again, waiting a while to reappear in hopes that public perception had changed.

That moment came earlier this month when Davies spoke to CoinDesk from an office in Dubai — another location with loose extradition laws with the United States — about the launch of OPNX.

Copy of FTX features

For all the issues that caused FTX to demise, the Sam Bankman-Fried exchange offered a series of features that set it apart from the crowd. Wallet Margin has revitalized crypto derivatives trading following the lackluster user experience that came from BitMEX. This allowed traders to hold a diversified portfolio while using face value to trade futures.

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This has been adopted by OPNX with one difference: users will be able to use bankruptcy claims as collateral. Given the sheer volume of crypto bankruptcies over the past year, demand for such a product seems likely to be high. But how does it work? What happens when a transaction using a bankruptcy claim as collateral is liquidated?

“We [OPNX] don’t take that claim risk,” Davies told CoinDesk. “Let’s say you have a $100,000 claim. You transfer your complaint to an SPV [special purpose vehicle]. OPNX then tokenizes this SPV.”

The SPV will then be added to a tranche of receivables linked to the bankruptcy which will create liquidity on an order book.

“If the claim is trading at 25 cents, you can sell your claim for $25,000 in stablecoins and withdraw. We will also have a safety net, which will be a large fund that wants to buy below the market,” added Davies. “The fund can bid for the whole tranche at, say, 20 cents in which case it can hold it for a month and then adjust it every month within a range.”

People can use bankruptcy claims, against the backstop, as collateral to trade bitcoin (BTC) or ether (ETH) derivatives. If a trader is liquidated, then the claim will be sold in the order book, which will eventually reach the collateral price. A backstop is a price level that provides deeper liquidity, intended to prevent an asset from falling below that level.

One of the issues that ultimately plagued FTX was that its sister company, Alameda Research, was the market maker for various trading pairs. This not only created a conflict of interest, but also resulted in Alameda having unlimited risk parameters, which ultimately caused a shortfall of liquid assets versus liabilities.

OPNX will not have internal market makers. Instead, it will pay market makers to ensure that all order books maintain a level of liquidity that can withstand the volatility of crypto derivatives exchanges.

On the surface, OPNX is a novel idea. It has immediate demand from those looking to recoup losses from bankrupt crypto companies and it has embraced several features that have helped FTX become a market leader. Whether investors will trust Davies and Zhu remains to be seen.

A “legitimate” – although undisclosed – location

Starting a crypto exchange in the current market dynamics is definitely a risk. Macro headwinds and an emerging banking crisis could put a damper on this year’s crypto rout, but OPNX plans to roll out a series of phases that will include the tokenization of other assets like real estate and stocks.

Regulatory restrictions will be a natural obstacle. Davies said OPNX had applied for a regulated exchange license in a currently undisclosed jurisdiction. “It’s a legitimate jurisdiction,” Davies said.

When asked if Davies and Zhu would start another hedge fund or trading company once the dust settled after the collapse of Three Arrows Capital, Davies was timid and defensive.

“My thinking right now is if we want people to judge our product, not us,” he said. “If you think about why people are angry, it has nothing to do with me actually. People are angry because the market has gone down. As far as we are concerned, we have no regulatory measure [against us] anywhere, no trial at all. There is nothing. So they’re clearly not mad at anything. They’re angry because the supercycle didn’t happen, maybe, I don’t know. Something like that, right?”