Curve's founder, Michael Egorov, has introduced a market-based approach to resolve approximately $700,000 in bad debt associated with LlamaLend, the platform's lending arm. In a governance post, Egorov outlined a 'free-market based method of recovery with option-like payoff,' inviting Curve DAO to participate but not requiring its involvement. The bad debt stems from LlamaLend's CRV-long market, where users can borrow crvUSD, a stablecoin, against CRV, the protocol's governance token. This setup essentially functions as a bet on CRV's value remaining stable or increasing.
However, if CRV's value drops rapidly, the collateral may not be sold quickly enough to fully repay lenders. This scenario played out following the October 10 crash, triggered by an announcement from President Donald Trump regarding tariffs on Chinese goods. Rather than seeking a bailout from Curve's DAO, Egorov proposes packaging the affected lender positions into a tokenized vault, 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. 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 immune to the damage. Prices plummeted, and gas costs rose, leading to a situation 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. LLAMMA converts collateral in steps as the market moves, rather than selling it all at once when prices fall. However, during the October 10 crash, the market moved too quickly, and arbitrage traders, who help maintain the system's balance, 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 because the loss is not open-ended. The distressed positions already hold crvUSD converted from CRV, so further declines in CRV should not exacerbate 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.
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, purchasing 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. The proposal's timing is noteworthy, given the recent exploit of Kelp DAO's LayerZero bridge, which resulted in Aave facing up to $230 million in bad debt. The industry response has been a coordinated bailout effort, DeFi United, which has raised approximately $160 million.
Egorov presents Curve's pool as an alternative model, building a market for distressed claims and allowing buyers to determine the price. If successful, this approach could be applied to similar situations at Curve or other protocols.