Michael Egorov, the founder of Curve, has put forth a market-based solution to tackle the issue of approximately $700,000 in bad debt associated with LlamaLend, Curve's lending platform. In a governance post, Egorov outlined a plan that involves packaging the affected lender positions into a tokenized vault, which would then be made available for purchase and sale through a dedicated Curve pool. This approach would allow trapped lenders to exit their positions while enabling outside buyers to determine the value of the distressed claims.

The goal is to provide a way out for lenders while allowing the market to decide the worth of the claims. The bad debt in question stems from a crash that occurred on October 10, resulting in over $19 billion in leveraged liquidations within a matter of hours. Curve's crvUSD minting markets withstood the sell-off, but LlamaLend was not entirely spared from the damage.

Prices plummeted, and gas costs rose, leading to a scenario where some liquidations could not occur in time. As a result, lenders in the CRV-long market were left with deposits backed by only about 70% of their stated value. Egorov's proposal is designed to address this issue by creating a market for the distressed claims, rather than relying on a bailout. The plan would utilize Curve's Stableswap design, with a 1% swap fee and liquidity centered around 71% solvency.

This would allow the pool to price the token closer to its current backing, rather than its full value. For trapped depositors, the pool offers a choice: they can either hold on to their positions in anticipation of a CRV recovery or sell their vault tokens at a discount and move on. For buyers, the trade represents a long-term bet on CRV, with the potential for the token to increase in value if CRV recovers. The proposed pool would also provide liquidity providers with swap fees and any CRV incentives allocated by Curve's DAO.

The timing of the proposal is notable, given the recent exploit of Kelp DAO's LayerZero bridge, which resulted in Aave facing up to $230 million in bad debt. The industry response has been a coordinated bailout effort, but Egorov's proposal presents a different approach, one that relies on market forces to resolve the issue rather than a centralized bailout.

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