Curve founder Michael Egorov has unveiled 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 allow Curve DAO to participate but not obligate it.
The proposal involves packaging the affected lender positions into a tokenized vault, enabling traders to buy and sell them through a dedicated Curve pool. This approach aims to provide trapped lenders with an exit strategy while allowing outside buyers to determine the value of the distressed claims. The bad debt stems from a crash on October 10, which resulted in over $19 billion in leveraged liquidations and saw CRV's value plummet. LlamaLend's CRV-long market, designed to reduce risk through an automated market maker, was unable to fully mitigate the damage.
As a result, lenders were left with deposits backed by approximately 70% of their stated value. Egorov's proposal seeks to address this issue by creating a market for distressed claims, allowing buyers to purchase tokenized vaults at a discount. This would provide trapped depositors with a choice: wait for CRV's potential recovery or sell their vault tokens at a reduced price.
For buyers, the trade represents a long-term bet on CRV's recovery, with the token possessing an 'interesting option-like property.' The proposed pool would utilize Curve's Stableswap design, with a 1% swap fee and liquidity centered around 71% solvency. This approach would enable liquidity providers to earn swap fees and CRV incentives while allowing the DAO to retain admin fees in the distressed vault token.
The timing of the proposal coincides with Aave's recent bad debt crisis, which has prompted a coordinated bailout effort. In contrast, Egorov's plan presents a market-driven solution, where buyers determine the price of distressed claims rather than relying on industry-wide bailouts.
If successful, this pilot study could be applied to similar situations at Curve or other protocols, offering a novel approach to addressing bad debt in the DeFi space.