Curve founder Michael Egorov has introduced a market-based solution to tackle approximately $700,000 of 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 enable participants to invest in the recovery efforts. The proposal does not require Curve DAO's involvement, although it is invited to participate. The bad debt is a result of the October 10 crash, which led to a significant decline in CRV's value.
The loss is currently sitting in LlamaLend's CRV-long market, where users can borrow Curve's crvUSD stablecoin against CRV, the protocol's governance token. To address the issue, Egorov suggests packaging the affected lender positions into a tokenized vault, allowing traders to buy and sell them through a dedicated Curve pool. This approach would provide trapped lenders with an exit strategy while enabling outside buyers to determine 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.
This means the pool would not treat the distressed token as if it were worth its full value; instead, it would price the token closer to its current backing. For trapped depositors, the pool offers a choice: they can either hold on to their vault tokens and wait for CRV's potential recovery or sell them at a discount and move on.
For buyers, the trade represents a long-term bet on CRV's recovery, with the token having an 'interesting option-like property' due to its partial backing. The proposal comes at a time when the DeFi industry is addressing bad debt issues, with Aave facing up to $230 million in bad debt following an exploit on Kelp DAO's LayerZero bridge. While Aave is coordinating a bailout through DeFi United, Egorov's proposal presents a different model, where Curve would create a market for distressed claims and let buyers determine the price. If successful, this pilot study could be applied to similar situations at Curve or other protocols, providing an alternative solution to bad debt in the DeFi space.