Curve's founder, Michael Egorov, has put forth a market-driven approach to address approximately $700,000 in bad debt associated with LlamaLend, Curve's lending platform. Egorov outlined a free-market-based recovery method with an option-like payoff, inviting Curve DAO to participate but not requiring it. The bad debt stems from LlamaLend's CRV-long market, where users borrow crvUSD stablecoins against CRV, the protocol's governance token.
This trade functions as a bet that CRV will maintain or increase in value. If CRV falls too rapidly, the collateral may not be sold quickly enough to repay lenders in full.
Following the October 10 crash, triggered by President Donald Trump's announcement of tariffs on Chinese goods via Truth Social, CRV's value plummeted. As a result, lenders in the CRV-long market were left 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 strategy while enabling outside buyers to determine 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 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 CRV's potential recovery or sell their vault tokens at a discount and move on.
For buyers, the trade represents a long-term bet on CRV, as they purchase a claim that is partly backed and could increase in value if CRV recovers. Egorov characterized the token as having an 'interesting option-like property' on CRV's recovery, with some backing already in place.
The token's fair price and price floor would increase if CRV's price rises, without 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. Administrative fees would partly accrue in the distressed vault token itself, which Egorov has asked the DAO to retain rather than convert.
This approach 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, 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 presents Curve's pool as an alternative model, allowing the market to determine the price of distressed claims rather than relying on a bailout. If successful, this approach could be applied to similar situations at Curve or other protocols.