Curve's founder, Michael Egorov, has unveiled a market-based plan to tackle approximately $700,000 in bad debt associated with LlamaLend, the platform's lending arm. The proposal involves creating a tokenized vault for affected lender positions, which can then be bought and sold through a dedicated Curve pool. This approach enables trapped lenders to exit their positions while allowing outside buyers to determine the value of the distressed claims. The bad debt stems from the October 10 crash, which saw over $19 billion in leveraged liquidations and left lenders in the CRV-long market with deposits backed by only about 70% of their stated value.
Egorov's plan aims to provide a way out for these lenders while giving buyers an opportunity to make a long-term bet on CRV's recovery. The proposed pool would utilize Curve's Stableswap design, with a 1% swap fee and liquidity centered around 71% solvency. This means the pool would price the distressed token closer to its current backing rather than its full value. For trapped depositors, the pool offers a choice: they can either hold on to their vault tokens in anticipation of a CRV recovery or sell them at a discount and move on.
Buyers, on the other hand, can purchase a claim that is partly backed and has the potential to increase in value if CRV recovers. The token has an 'interesting option-like property' on CRV's recovery, 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 bad debt, particularly in the wake of an attacker exploiting Kelp DAO's LayerZero bridge and releasing unbacked rsETH worth approximately $292 million. Aave now faces up to $230 million in bad debt, prompting a coordinated bailout effort through DeFi United.
Egorov's proposal presents a different model, one that relies on building a market for distressed claims rather than seeking a bailout. If successful, this approach could be applied to similar situations at Curve or other protocols.