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

Curve's founder, Michael Egorov, has introduced a market-based approach to address approximately $700,000 in bad debt associated with LlamaLend, the platform's lending service. In a governance post, Egorov outlined a 'free-market based method of recovery with option-like payoff,' which would function as an investment opportunity for those willing to participate in the recovery efforts. Curve DAO has been invited to participate but is not required to do so.

The bad debt stems from LlamaLend's CRV-long market, where users can borrow Curve's crvUSD stablecoin against CRV, the protocol's governance token. This trade essentially serves as a bet 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 repay lenders in full. This scenario occurred after the October 10 crash, triggered by President Donald Trump's announcement of tariffs on all Chinese goods via a post on Truth Social.

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

LlamaLend's bad debt resulted from the October 10 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 approximately 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 since the loss is not open-ended. The distressed positions already hold crvUSD converted from CRV, so further CRV declines should not deepen the shortfall.

If CRV 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. Egorov stated that 'if CRV price grows up, positions with bad debt will deliquidate,' meaning the system would start converting crvUSD back into CRV collateral.

'If, however, CRV goes down, collateral is already converted to crvUSD, so the vault deposits will not be less backed.' At the time of writing, CRV is trading near $0.23, well below both levels. 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, as 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, with some backing already in place, according to Egorov.

The 'fair price and price floor go up if CRV price goes up, and does not go down if CRV price goes down,' he wrote. 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 proposal's timing is noteworthy, as it comes after an attacker exploited Kelp DAO's LayerZero bridge and released 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, prompting 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.

KelpDAO, one of the entities affected by the exploit, has committed 2,000 ETH to DeFi United, joining a group of major Ethereum-linked organizations. It is currently unclear whether LayerZero is participating in the initiative. Egorov is positioning Curve's pool as a different model, where instead of relying on industry-wide bailouts, Curve would create a market for distressed claims and allow buyers to determine the price.

If this approach proves successful, Egorov believes it could be applied to 'similar difficult situations' at Curve or other protocols.