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

Curve's founder, Michael Egorov, has put forth a market-driven approach 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,' which would function as an investment opportunity for those wanting to participate. He emphasized that Curve DAO is invited but not required to take part. The bad debt is currently situated in LlamaLend's CRV-long market, where users can borrow Curve's crvUSD stablecoin against CRV, the protocol's governance token.

This trade operates as a wager that CRV will maintain or increase its value. If CRV experiences a rapid decline, the collateral may not be sold quickly enough to repay lenders in full. This scenario unfolded following 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 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. LlamaLend's bad debt stems 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 surged, resulting in 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, LLAMMA, which is integrated into the lending system.

Instead of selling a borrower's collateral all at once when prices fall, LLAMMA converts the collateral in stages as the market moves. According to Egorov, the providers of borrowable liquidity in this market were exposed to losses during liquidation protection, and as a result, they 'cannot withdraw their positions,' which are 'currently 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.

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 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 noted that if CRV's price grows, positions with bad debt will deliquidate, meaning the system would start converting crvUSD back into CRV collateral. If, however, CRV's price declines, the 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. 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, 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 timing of the proposal adds weight, as it comes on the heels of an attacker exploiting Kelp DAO's LayerZero bridge and releasing 116,500 unbacked rsETH worth about $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 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 presenting Curve's pool as a different model, one that would build a market for distressed claims and let buyers decide the price, rather than passing the hat across the industry. If this proves to be a successful pilot study, Egorov wrote, it could be applied in 'similar difficult situations' at Curve or other protocols.