Curve 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. In a governance post, Egorov outlined a 'free-market based method of recovery with option-like payoff,' which would function as an investment opportunity for those willing to participate. He emphasized that Curve DAO is invited to take part but is not obligated to do so.
The bad debt is currently situated in LlamaLend's CRV-long market, where users can borrow Curve's crvUSD stablecoin against CRV, the protocol's governance token. This trade essentially serves as a wager that CRV's value will either hold steady or increase. If CRV's value drops too rapidly, the collateral may not be sold quickly enough to fully repay lenders. This scenario unfolded following the October 10 crash, which was 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 primary objective is to provide trapped lenders with an exit strategy while enabling outside buyers to determine the value of the distressed claims. LlamaLend's bad debt stems from the crash, which resulted in over $19 billion in leveraged liquidations within a matter of hours – the largest single-day deleveraging on record. Although Curve's crvUSD minting markets withstood the sell-off, LlamaLend was not entirely immune to the damage.
As prices plummeted and gas costs rose, a situation arose where some liquidations could not occur in a timely manner. Lenders in the CRV-long market were left with deposits backed by roughly 70% of their stated value. The market is designed to mitigate this risk through an automated market maker integrated into the lending system, known as LLAMMA. Instead of selling a borrower's collateral all at once when prices drop, LLAMMA converts the collateral in stages as the market moves.
Egorov explained that the providers of borrowable liquidity in this market were exposed to losses during liquidation protection and, as a result, are currently unable to withdraw their positions, which are approximately 70% backed. However, during the October 10 crash, the market moved too rapidly. Arbitrage traders, who help maintain the system's balance by buying and selling across price gaps, were unable to keep pace.
Consequently, 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 that was converted from CRV, so further declines in CRV's value should not exacerbate the shortfall. If CRV's price rises above approximately $0.96, the conversion process begins to reverse, and the positions start taking in CRV collateral again.
A full recovery would occur around $1.24. According to Egorov, 'if CRV price grows up, positions with bad debt will deliquidate,' meaning the system would start converting crvUSD back into CRV collateral. 'If, however, CRV goes down, collateral is already converted to crvUSD, so the vault deposits will not be less backed.' At the time of writing, CRV is trading near $0.23, significantly below both levels. The proposed pool would utilize Curve's Stableswap design, featuring a 1% swap fee and liquidity centered around 71% solvency rather than full value.
This means the pool would not treat the distressed token as if it were worth one dollar on the dollar; instead, it would price the token closer to its current backing. For trapped depositors, the pool offers a choice: they can either continue waiting 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 would be purchasing a claim that is partly backed today and could potentially increase in value if CRV recovers. This gives the token an 'interesting option-like property' on CRV's recovery, albeit with some backing already in place, according to Egorov.
'ts fair price and price floor go up if CRV price goes up, and does not go down if CRV price goes down,' he wrote. Liquidity providers in the new pool would earn swap fees and any CRV incentives that Curve's DAO chooses to allocate.
Admin fees would partly accrue in the distressed vault token itself. Egorov has requested that the DAO retain these tokens rather than convert them, which would gradually transfer some of the bad debt onto Curve's balance sheet through trading activity.
The proposal's timing lends it added significance, as it comes on the heels of an attacker exploiting Kelp DAO's LayerZero bridge and 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 an industry-wide response in the form of a coordinated bailout through DeFi United, a recovery effort led by Aave service providers that has raised around $160 million of the roughly $200 million needed so far. Egorov is positioning Curve's pool as an alternative model, where instead of relying on industry-wide bailouts, Curve would establish a market for distressed claims and allow buyers to determine the price.
If this pilot study proves successful, Egorov suggests it could be applied to similar challenging situations at Curve or other protocols.