A look at Three Arrows’ past crypto bets – on Luna and Axie Infinity, as well as Bitcoin and Ether – leaves little doubt that “communication” is probably not the fun kind. The fund, which is estimated to manage $10 billion in assets as of March, combined Zhu’s expertise in derivatives with a kind of blissful conviction in a broad crypto “supercycle” (which he has recently admitted to be false).

The fact that waves of forced sells always seem to ripple through the crypto markets shows just how complex and lending-driven this market has become. Margin calls from traditional finance take on a more brutal form in crypto when smart contracts automatically liquidate positions in quick succession. The current focus is on Three Arrows’ exposure to staked Ether, a token designed to generate interest while Ethereum improves its network, which is giving way under heavy selling pressure.

But it also suggests that the lessons of history are being ignored. This is not the first boom and bust cycle for Bitcoin or the broader crypto market; The Bloomberg Galaxy Crypto Index’s 65% decline this year is similar to that seen at the start of 2018. Yet hedge funds set up to deliver above-market returns in crypto appear 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 “just stopped trading,” he says, with the tracked total falling to 325 from 510 in January.

The risk of a widespread crypto meltdown — the kind that humiliated token picking strategies in 2018 — doesn’t seem to have been high on their radar. The kind of strategies exploiting inefficiencies between exchanges that could generate returns of 6% to 10% have been leveraged by funds using DeFi lending platforms offering lucrative rates – which are proving unsustainable. As one hedge funder told me, it’s like picking up BMWs instead of pennies in front of a steamroller. The end result always involves being crushed.

With over 40% of crypto funds using borrow and lend strategies, according to PWC, the current turmoil feels like a carpet rather than a trade intelligence vindication. The winners are probably those who simply got their money back on time. Two-thirds of crypto funds are likely to fail, Mike Novogratz estimates. Short sellers seem to be in short supply.

Three Arrows’ Zhu may have spoken for many investors earlier this year when he said the lesson from the fall of 2018 was to stay optimistic and not give in to “desperation”. Hence his praise for all sorts of clearly speculative shenanigans like Axie Infinity, a crypto game that pays people to spend their days raising virtual pets that have been battered by deflating hype and a $620 million hack. dollars. His rationales seemed shrouded in futurism rather than risk management: his “bible,” the 1997 book “The Sovereign Individual,” foresaw some of the social upheavals of the internet age.

Maybe Zhu should have read “When Genius Failed”. As Novogratz has observed, what’s happening in crypto echoes the 1998 explosion of Long-Term Capital Management, a hedge fund full of very smart people, including two Nobel laureates, dealing with investment strategies. sophisticated arbitrage powered by derivatives. When the unthinkable happened and the losses piled up, the banks called back their loans and eventually took over the business.

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

But that doesn’t change the fact that the real losses are racked up by the funds and bettors who are least able to afford them. Whatever happens to Three Arrows, the lesson of 2022 – crypto prices can go down and can continue to go down – should not be forgotten as 2018 was.

More from Bloomberg Opinion:

• This crypto winter will be long, cold and harsh: Jared Dillian

• Celsius Crypto FOMO has also attracted finance professionals: Lionel Laurent

• Gen Z gets a hard lesson on stock market risk: Allison Schrager

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Lionel Laurent is a Bloomberg Opinion columnist covering digital currencies, the European Union and France. Previously, he was a reporter for Reuters and Forbes.

More stories like this are available at bloomberg.com/opinion