Curve's founder, Michael Egorov, has put forth a market-based solution to tackle approximately $700,000 in bad debt associated with LlamaLend, Curve's lending platform. In a governance post, Egorov outlined a plan that enables trapped lenders to sell tokenized claims on deposits, offering buyers an option-like bet on CRV's potential recovery. 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. The trade functions as a wager that CRV will maintain its value or appreciate.

However, if CRV's value plummets too rapidly, the collateral may not be sold quickly enough to repay lenders in full, resulting in a shortfall. This scenario unfolded 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 objective is to provide trapped lenders with an exit strategy while permitting outside buyers to determine the value of the distressed claims.

LlamaLend's bad debt resulted from the crash, which saw over $19 billion in leveraged liquidations within hours, marking the largest single-day deleveraging on record. Curve's crvUSD minting markets withstood the sell-off, but LlamaLend was not entirely immune to the damage. Prices fell rapidly, while gas costs rose, leading to a situation 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 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. However, during the October 10 crash, the market moved too quickly, and arbitrage traders could not 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 converted from CRV, so further CRV declines should not deepen the shortfall. If CRV rises above roughly $0.96, the conversion starts to reverse, and the positions begin taking in CRV collateral again.

Full recovery would occur around $1.24. The proposed pool would utilize Curve's Stableswap design, with a 1% swap fee and liquidity centered around 71% solvency rather than full value.

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 more valuable if CRV recovers. The token possesses an 'interesting option-like property' on CRV's recovery, with some backing already in place. The timing of the proposal adds weight, as it comes after an attacker exploited Kelp DAO's LayerZero bridge, releasing 116,500 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, where Curve would build 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.