Curve's founder, Michael Egorov, has put forth a market-based approach to resolve approximately $700,000 in bad debt stemming from LlamaLend, the platform's lending arm. In a governance post, Egorov outlined a method that enables trapped lenders to sell tokenized claims on deposits, effectively offering buyers an opportunity to wager on the potential recovery of CRV, Curve's governance token. This approach is distinct from a traditional bailout, as seen in Aave's recent situation, where the industry collectively contributed funds to alleviate the debt.
Instead, Curve's proposal involves creating a tokenized vault for affected lender positions, which can then be bought and sold through a specialized Curve pool. The goal is to provide an exit strategy for lenders while allowing external buyers to determine the value of the distressed claims.
The bad debt in question originated from a market crash on October 10, which resulted in over $19 billion in leveraged liquidations within a matter of hours. Although Curve's crvUSD minting markets remained stable, LlamaLend was not entirely unaffected, with lenders in the CRV-long market left with deposits backed by only about 70% of their stated value. Egorov's proposal involves packaging these affected positions into a tokenized vault, enabling traders to purchase and sell them through the dedicated Curve pool. This approach would give trapped lenders a means to exit their positions while allowing outside buyers to assess the value of the distressed claims.
The proposed pool would utilize Curve's Stableswap design, featuring a 1% swap fee and liquidity centered around 71% solvency. This would result in the pool pricing the token closer to its current backing rather than its full value.
For lenders, this presents an opportunity to either hold out for a potential CRV recovery or sell their vault tokens at a discounted rate. Buyers, on the other hand, would be making a long-term bet on CRV's potential recovery, purchasing a claim that is partially backed and may increase in value if CRV recovers. The token in question would possess an 'option-like property,' with its fair price and price floor increasing if CRV's price rises, but not decreasing if CRV's price falls. Liquidity providers in the new pool would earn swap fees and any CRV incentives allocated by Curve's DAO.
The proposal comes at a time when the DeFi industry is grappling with the issue of bad debt, as seen in the recent Aave exploit, which resulted in up to $230 million in bad debt. The industry's response has been a coordinated bailout effort, with Aave service providers and other major players contributing to a recovery fund. In contrast, Curve's proposal presents a market-driven solution, where the value of distressed claims is determined by buyers rather than relying on a collective industry effort.
If successful, this approach could serve as a model for addressing similar situations in the future, both within Curve and other protocols.