Curve founder Michael Egorov has put forth a market-based solution to tackle approximately $700,000 in 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 function as an investment opportunity for those willing to participate. The proposed solution involves packaging the 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 strategy while enabling outside buyers to determine the value of the distressed claims. The bad debt in question arose from a crash on October 10, which resulted in over $19 billion in leveraged liquidations. Despite Curve's crvUSD minting markets withstanding the sell-off, LlamaLend suffered losses due to rapid price declines and rising gas costs, leading to a scenario where some liquidations could not occur in time.
Lenders in the CRV-long market were left with deposits backed by roughly 70% of their stated value. Egorov's proposal seeks to address this issue by creating a market for the distressed claims, allowing buyers to purchase them at a discounted price. The tokenized vault would have an 'interesting option-like property,' with its value potentially increasing if CRV recovers. For trapped depositors, the proposed pool offers a choice: they can either hold on to their vault tokens in anticipation of a CRV recovery or sell them at a discount and move on.
Meanwhile, buyers would be making a long-term bet on CRV's potential recovery, purchasing a claim that is partly backed today and could become more valuable in the future. The proposed pool would utilize Curve's Stableswap design, with a 1% swap fee and liquidity centered around 71% solvency. This would allow the pool to price the token closer to its current backing rather than its full value. Egorov's proposal comes at a time when the DeFi industry is grappling with bad debt, particularly in the wake of an attacker exploiting Kelp DAO's LayerZero bridge, resulting in Aave facing up to $230 million in bad debt.
In contrast to the coordinated bailout efforts for Aave, Curve's proposed solution presents a market-driven approach, where buyers would determine the price of the distressed claims. If successful, this pilot study could be applied to similar situations at Curve or other protocols, providing an alternative model for addressing bad debt in the DeFi space.