Curve founder Michael Egorov has unveiled a market-based solution to address approximately $700,000 in bad debt associated with LlamaLend, Curve's lending platform. In a governance post, Egorov proposed a free-market recovery method with an option-like payoff, open to all who wish to participate. The plan involves packaging affected lender positions into a tokenized vault, allowing traders to buy and sell them through a dedicated Curve pool.
This approach aims to provide trapped lenders with an exit option while enabling 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, the largest single-day deleveraging on record. Curve's crvUSD minting markets withstood the sell-off, but LlamaLend was not entirely unscathed. Prices plummeted, and gas costs soared, leading to a scenario where some liquidations could not occur in time.
Lenders in the CRV-long market were left with deposits backed by about 70% of their stated value. Egorov's proposal seeks to address this issue by creating a market for distressed claims, allowing buyers to decide their value. The proposed pool would utilize Curve's Stableswap design, with a 1% swap fee and liquidity centered around 71% solvency. 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, with the potential for increased value if CRV recovers. The token has an 'interesting option-like property' on CRV's recovery, with some backing already in place. Egorov has asked the DAO to retain the tokens rather than convert them, which would gradually transfer some of the bad debt onto Curve's balance sheet through trading activity.
The proposal comes at a time when the DeFi industry is addressing bad debt, with Aave facing up to $230 million in bad debt following an exploit on Kelp DAO's LayerZero bridge. The industry response has been a coordinated bailout through DeFi United, a recovery effort led by Aave service providers. Egorov's proposal presents a different model, where Curve would build 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.