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 proposed a 'free-market based method of recovery with 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.
When CRV's value plummeted after the October 10 crash, some lenders were left with deposits backed by only about 70% of their stated value. Egorov's plan involves packaging the affected lender positions into a tokenized vault, allowing traders to buy and sell them through a dedicated Curve pool. This approach aims to provide trapped lenders with an exit strategy while enabling outside buyers to determine the value of the distressed claims.
The tokenized vault would utilize Curve's Stableswap design, with a 1% swap fee and liquidity centered around 71% solvency. For trapped depositors, the pool offers a choice: wait for CRV's recovery or sell their vault tokens at a discount.
Buyers, on the other hand, can purchase a claim that is partly backed, with the potential to increase in value if CRV recovers. The proposed solution has an 'interesting option-like property,' with its fair price and price floor increasing if CRV's price rises, but not decreasing if CRV's price falls. The timing of the proposal coincides with Aave's recent bad debt issue, which has prompted a coordinated bailout effort. In contrast, Curve's approach focuses on building a market for distressed claims, allowing buyers to determine the price.
If successful, this pilot study could be applied to similar situations in the future, providing an alternative model for addressing bad debt in the DeFi space.