Curve's founder, Michael Egorov, has introduced a market-based approach to resolve approximately $700,000 in bad debt associated with LlamaLend, the platform's lending arm. Egorov outlined a 'free-market based method of recovery with option-like payoff' in a governance post, stating that Curve DAO is 'invited but not required' to participate.

The bad debt is tied to LlamaLend's CRV-long market, where users can borrow the crvUSD stablecoin against CRV, the protocol's governance token. This trade functions as a bet that CRV's value will hold or increase. However, if CRV's value falls rapidly, the collateral may not be sold quickly enough to repay lenders in full.

Following the October 10 crash, which was triggered by President Donald Trump's announcement of tariffs on Chinese goods via Truth Social, the collateral's value plummeted. As a result, some liquidations could not occur in time, leaving lenders with deposits backed by only about 70% of their stated value. Egorov proposes packaging the affected lender positions into a tokenized vault, allowing traders to buy and sell them through a dedicated Curve pool. The goal is to provide trapped lenders with an exit option while enabling outside buyers to determine the value of the distressed claims.

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 not treat the distressed token as if it were worth its full value; instead, it would price the token closer to its current backing.

For trapped depositors, the pool offers a choice: they can either wait for a potential CRV recovery or sell their vault tokens at a discount and move on. For buyers, the trade represents a long-term bet on CRV's recovery, as they purchase a claim that is partly backed and could increase in value if CRV recovers. The token has an 'interesting option-like property' on CRV's recovery, with some backing already in place.

Its 'fair price and price floor go up if CRV price goes up, and does not go down if CRV price goes down,' according to Egorov. 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, which Egorov has asked the DAO to retain rather than convert. This would gradually transfer some of the bad debt to Curve's balance sheet through trading activity.

The proposal comes at a time when the DeFi industry is addressing bad debt. Earlier this month, 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, prompting a coordinated bailout effort through DeFi United, which has raised around $160 million of the roughly $200 million needed so far.

Egorov presents Curve's pool as an alternative model, where instead of relying on industry-wide bailouts, Curve would create a market for distressed claims and let buyers determine the price. If this pilot study proves successful, it could be applied to similar situations at Curve or other protocols, according to Egorov.