Curve Founder Proposes Market-Driven Solution for $700,000 in Troubled Debt

Curve's founder, Michael Egorov, has put forth a market-driven approach to tackle approximately $700,000 in bad debt associated with LlamaLend, Curve's lending platform. In a governance post, Egorov suggested a free-market-based recovery method with an option-like payoff, open to all who wish to participate. He emphasized that Curve DAO is invited but not required to take part. The bad debt stems from LlamaLend's CRV-long market, where users can borrow the crvUSD stablecoin against CRV, the protocol's governance token.

This trade functions as a bet that CRV will maintain or increase its value. However, if CRV's value plummets too quickly, the collateral may not be sold rapidly enough to repay lenders in full.

This scenario unfolded after the October 10 crash, triggered by President Donald Trump's announcement of tariffs on Chinese goods via Truth Social. Rather than relying on Curve's DAO to cover the shortfall, Egorov proposes packaging the affected lender positions into a tokenized vault and allowing traders to buy and sell them through a dedicated Curve pool. The objective is to provide trapped lenders with an exit strategy while enabling outside buyers to determine the value of the distressed claims.

LlamaLend's bad debt resulted from the 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 spared. As prices plummeted and gas costs rose, 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. According to Egorov, the providers of borrowable liquidity in this market were exposed to losses during liquidation protection and 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, could not keep up, resulting in some lender positions being relegated to 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 exacerbate the shortfall. If CRV rises above approximately $0.96, the conversion begins to reverse, and the positions start taking in CRV collateral again. Full recovery would occur around $1.24.

Egorov noted 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 drops, 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 its current backing. For trapped depositors, the pool offers a choice: they can 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 on CRV's recovery, with some backing already in place, according to Egorov. The fair price and price floor of the token increase if CRV's price rises and do not decrease if CRV's price falls.

Liquidity providers in the new pool would earn swap fees and any CRV incentives allocated by Curve's DAO. Admin fees would partly accrue in the distressed vault token itself. Egorov has requested that the DAO retain these tokens rather than convert them, which would gradually transfer some of the bad debt onto Curve's balance sheet through trading activity.

The proposal's timing is significant, as it comes after an attacker exploited Kelp DAO's LayerZero bridge, releasing 116,500 unbacked rsETH worth approximately $292 million. Aave now faces up to $230 million in bad debt, prompting a coordinated bailout effort through DeFi United, which has raised around $160 million of the roughly $200 million needed so far. Egorov is presenting Curve's pool as a different model, one that builds a market for distressed claims and allows buyers to determine the price, rather than relying on a bailout. If this approach proves successful, it could be applied to similar challenging situations at Curve or other protocols, according to Egorov.