Michael Egorov, the founder of Curve, has put forth a market-oriented solution to tackle approximately $700,000 in bad debt associated with LlamaLend, Curve's lending platform. In a governance post, Egorov outlined a 'free-market based method of recovery with option-like payoff,' inviting Curve DAO to participate but not requiring its involvement. The bad debt is currently situated in LlamaLend's CRV-long market, which allows users to borrow Curve's crvUSD stablecoin against CRV, the protocol's governance token. This trade functions as a wager that CRV will maintain its value or increase.

If CRV declines too rapidly, the collateral may not be sold quickly enough to repay lenders in full. This scenario unfolded after the October 10 crash, triggered by President Donald Trump's announcement of tariffs on all Chinese goods via a post on Truth Social.

Instead of requesting Curve's DAO to cover the shortfall, Egorov proposes packaging the affected lender positions into a tokenized vault and allowing traders to buy and sell them through a dedicated Curve pool. The objective is to provide trapped lenders with an exit strategy while enabling outside buyers to determine the value of the distressed claims.

The bad debt resulted from the crash, which saw over $19 billion in leveraged liquidations within hours, the largest single-day deleveraging on record. Curve's crvUSD minting markets withstood the sell-off, but LlamaLend did not fully escape the damage. Prices fell rapidly while gas costs rose, leading to a scenario where some liquidations could not occur in time.

Lenders in the CRV-long market were left with deposits backed by approximately 70% of their stated value. The market is designed to mitigate this risk through an automated market maker built into the lending system LLAMMA. Instead of selling a borrower's collateral all at once when prices fall, LLAMMA converts the collateral in steps as the market moves.

Egorov argued that the token still holds value because the loss is not open-ended. The distressed positions already hold crvUSD that was converted from CRV, so further CRV declines should not deepen the shortfall. If CRV rises above roughly $0.96, the conversion starts to reverse, and the positions begin taking in CRV collateral again. Full recovery would occur around $1.24.

The proposed pool would utilize Curve's Stableswap design, with a 1% swap fee and liquidity centered around 71% solvency rather than full value. That means the pool would not treat the distressed token as if it were worth one dollar on the dollar. It would price the token closer to the amount currently backing it. For trapped depositors, the pool offers a choice.

They can either wait for a CRV recovery or sell their vault tokens at a discount and move on. For buyers, the trade resembles a long-term bet on CRV.

They purchase a claim that is partly backed today and could become worth more if CRV recovers. This gives the token an 'interesting option-like property,' on CRV's recovery, but with some backing already in place. Liquidity providers in the new pool would earn swap fees and any CRV incentives that Curve's DAO chooses to allocate. Admin fees would partly accrue in the distressed vault token itself.

Egorov has asked the DAO to keep those tokens rather than convert them, which would slowly move some of the bad debt onto Curve's balance sheet through trading activity. The timing of the proposal adds weight, given the recent exploit of Kelp DAO's LayerZero bridge and the subsequent release of 116,500 unbacked rsETH worth about $292 million.

The attacker then deposited that unbacked rsETH into Aave as collateral and borrowed real WETH against it. Aave now faces up to $230 million in bad debt.

The industry response has been a coordinated bailout through DeFi United, a recovery effort led by Aave service providers that raised about $160 million of the roughly $200 million needed so far, with contributions from Mantle, Aave DAO, EtherFi, Lido, and Aave founder Stani Kulechov. Egorov is presenting Curve's pool as a different model, one that builds a market for distressed claims and lets buyers decide the price. If this proves to be a successful pilot study, it could be applied in similar difficult situations at Curve or other protocols.