Curve Founder Proposes Market-Driven Solution for $700,000 in Bad Debt

Curve founder Michael Egorov has put forth a market-based solution to address 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,' which would allow participants to invest in the recovery effort. The proposal invites Curve DAO to participate but does not require its involvement.

The bad debt is currently sitting in LlamaLend's CRV-long market, where users can borrow Curve's crvUSD stablecoin against CRV, the protocol's governance token. This trade functions as a wager that CRV's value will remain stable or increase.

However, if CRV's value drops rapidly, the collateral may not be sold quickly enough to fully repay lenders. Following the October 10 crash, which was triggered by President Donald Trump's announcement of tariffs on Chinese goods, the scenario played out exactly as described. Rather than relying on Curve's DAO to cover the shortfall, Egorov suggests packaging the affected lender positions into a tokenized vault, 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, marking the largest single-day deleveraging on record.

Although Curve's crvUSD minting markets withstood the sell-off, LlamaLend did not escape unscathed. Prices plummeted while gas costs rose, creating a scenario in which 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. According to Egorov, the providers of borrowable liquidity in this market were exposed to losses during liquidation protection and are currently unable to withdraw their positions, which are around 70% backed. However, during the October 10 crash, the market moved too rapidly.

Arbitrage traders, who help maintain the system's balance by buying and selling across price gaps, were unable to keep up. As a result, some lender positions ended up in a vault token that cannot be redeemed at full value today. 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's price rises above approximately $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. This means the pool would not treat the distressed token as if it were worth one dollar on the dollar; instead, 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, where they purchase a claim that is partly backed today and could become more valuable if CRV recovers.

This gives the token an 'interesting option-like property' on CRV's recovery, with some backing already in place. The fair price and price floor of the token increase if CRV's price rises and do not decrease if CRV's price falls.

Liquidity providers in the new pool would earn swap fees and any CRV incentives allocated by Curve's DAO. Admin fees would partly accrue in the distressed vault token itself.

Egorov has requested that the DAO retain these tokens rather than convert them, which would gradually transfer some of the bad debt onto Curve's balance sheet through trading activity. The timing of the proposal adds weight, as it comes after an attacker exploited Kelp DAO's LayerZero bridge, releasing 116,500 unbacked rsETH worth approximately $292 million. The attacker then deposited the 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 around $160 million of the roughly $200 million needed so far. Egorov is presenting Curve's pool as a different model, where instead of passing the hat across the industry, Curve would build a market for distressed claims and let buyers determine the price. If this proves to be a successful pilot study, it could be applied in similar difficult situations at Curve or other protocols.