Curve's founder, Michael Egorov, has put forth a market-driven approach to address approximately $700,000 in bad debt associated with LlamaLend, the platform's lending arm. Egorov outlined a 'free-market based method of recovery with option-like payoff' in a governance post, stating that Curve DAO is 'invited but not required' to participate. The bad debt is tied to LlamaLend's CRV-long market, which allows users to borrow Curve's crvUSD stablecoin against CRV, the protocol's governance token. This trade essentially functions as a bet that CRV will maintain its value or increase.
If CRV declines rapidly, the collateral may not be sold quickly enough to repay lenders in full. Following the October 10 crash, which occurred after President Donald Trump announced tariffs on all Chinese goods via a post on Truth Social, the collateral was not sold quickly enough.
Rather than requesting Curve's DAO to cover the shortfall, Egorov proposes packaging the affected lender positions into a tokenized vault, enabling traders to buy and sell them through a dedicated Curve pool. The primary goal is to provide trapped lenders with an exit strategy while allowing outside buyers to determine the value of the distressed claims. The bad debt resulted from the October 10 crash, which saw over $19 billion in leveraged liquidations within hours, marking the largest single-day deleveraging on record.
Although Curve's crvUSD minting markets withstood the sell-off, LlamaLend was not entirely unaffected. Prices dropped rapidly, while gas costs increased, resulting in a scenario where some liquidations could not occur in time.
Lenders in the CRV-long market were left with deposits backed by approximately 70% of their stated value. The market is designed to mitigate this risk through an automated market maker, LLAMMA, built into the lending system. Instead of selling a borrower's collateral all at once when prices fall, LLAMMA converts the collateral in steps 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, cannot withdraw their positions, which are currently around 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, could not keep up. 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 since the loss is not open-ended. The distressed positions already hold crvUSD converted from CRV, so further CRV declines should not deepen the shortfall. If CRV rises above approximately $0.96, the conversion starts to reverse, and the positions begin taking in CRV collateral again.
Full recovery would occur around $1.24. Egorov stated that if CRV's price grows, positions with bad debt will deliquidate, meaning the system would start converting crvUSD back into CRV collateral. If CRV's price declines, the 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, well below both levels.
The proposed pool would utilize Curve's Stableswap design, with 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 the amount currently backing it. 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.
This gives the token an 'interesting option-like property' regarding CRV's recovery, with some backing already in place. Egorov explained that the token's 'fair price and price floor go up if CRV price goes up, and does not go down if CRV price goes down.' 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 asked the DAO to keep those tokens rather than convert them, which would slowly move some of the bad debt onto Curve's balance sheet through trading activity.
The timing of the proposal adds weight, as it comes after an attacker exploited Kelp DAO's LayerZero bridge and released 116,500 unbacked rsETH worth about $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. The industry response has been a coordinated bailout through DeFi United, a recovery effort led by Aave service providers that raised about $160 million of the roughly $200 million needed so far, with contributions from Mantle, Aave DAO, EtherFi, Lido, and Aave founder Stani Kulechov.
KelpDAO, one of the entities affected by the exploit, has committed 2,000 ETH to DeFi United, joining a group of major Ethereum-linked organizations. It is currently unclear whether LayerZero is participating in the initiative. Egorov presents Curve's pool as a different model, where instead of passing the hat across the industry, Curve would build a market for distressed claims and let buyers decide the price.
If this proves to be a successful pilot study, Egorov wrote, it could be applied in 'similar difficult situations' at Curve or other protocols.