Curve founder Michael Egorov has introduced a market-based approach to address approximately $700,000 in bad debt associated with LlamaLend, Curve's lending platform. The proposed solution involves packaging the affected lender positions into a tokenized vault, enabling traders to buy and sell them through a dedicated Curve pool. This approach aims to provide trapped lenders with an exit option while allowing outside buyers to determine the value of the distressed claims.

The bad debt resulted from a crash on October 10, which saw over $19 billion in leveraged liquidations, the largest single-day deleveraging on record. Curve's crvUSD minting markets withstood the sell-off, but LlamaLend was not entirely unscathed. Prices plummeted while gas costs rose, leading to a scenario where some liquidations could not occur in time.

Lenders in the CRV-long market were left with deposits backed by about 70% of their stated value. Egorov's proposal involves creating a tokenized vault and letting traders buy and sell the affected positions through a dedicated Curve pool. The goal is to give trapped lenders a way out while allowing outside buyers to decide 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 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 has an 'interesting option-like property' on CRV's recovery, with some backing already in place. Egorov's proposal comes at a time when the DeFi industry is addressing bad debt, with Aave facing up to $230 million in bad debt following an exploit on Kelp DAO's LayerZero bridge.

The industry response has been a coordinated bailout through DeFi United, a recovery effort led by Aave service providers. In contrast, Curve's approach involves building a market for distressed claims and letting buyers determine the price.

If successful, this pilot study could be applied to similar situations at Curve or other protocols.