Credit Risk

Definition

Credit risk is the risk of financial loss to the protocol arising from a default, delayed payment, or deterioration in the credit quality of securities held as collateral. For USD0, credit risk would materialize if issuers of the underlying collateral assets fail to meet their obligations—such as paying interest on time or returning principal at maturity.

Impact on Usual’s Collateral

USD0 is backed by tokenized Real-World Assets (RWAs), primarily invested in short-term debt instruments such as US Treasury Bills, reverse repurchase agreements, and other highly liquid government instruments. While this is among the lowest-risk, yield-generating asset classes available, credit risk cannot be fully eliminated.

Some money market funds and tokenized RWA products may invest beyond sovereign debt, including commercial paper, certificates of deposit, and other short-term securities. If any collateral provider held instruments issued by entities with weak creditworthiness or under financial stress, the fund could suffer a decline in value and potentially incur direct losses—threatening the 1:1 backing of USD0.

To mitigate this risk, Usual applies a strict credit policy that prohibits corporate debt exposure and restricts investments to sovereign obligations only.

Collateral Eligibility Requirements

Before any RWA tokenizer is accepted as USD0 collateral, it must pass rigorous due diligence. From a credit risk perspective, the key requirements are:

Criterion	Requirement
Asset type	US Treasury Bills, quasi-government debt, or cash only
Corporate debt	Strictly prohibited
Collateralization	Must be fully collateralized with no leverage or fractional reserve exposure
Duration	Portfolio duration must remain below 0.33 years (~4 months)
Liquidity	Redeemable or sellable with minimal slippage within a maximum of 5 days
Transparency	On-chain verifiable reserves with frequent independent off-chain audits

These requirements ensure USD0 collateral is exposed only to sovereign credit risk (primarily the US government), which is generally considered the lowest available credit risk among yield-generating assets.

Risk Monitoring and Management

Usual uses a three-line-of-defense framework to monitor and mitigate credit risk across all accepted collateral.

1) First Line of Defense: Zero-Tolerance Policy

• Usual maintains a zero-tolerance posture for credit risk by restricting investments exclusively to US Treasuries, quasi-government debt, or cash.

• Corporate debt is strictly prohibited across all accepted tokenized RWA providers.

• This policy is enforced at onboarding: any tokenizer with corporate debt exposure is ineligible as USD0 collateral.

2) Second Line of Defense: Asset Manager Controls

• Usual only invests in tokenized RWA funds where corporate debt is explicitly prohibited at the fund level.

• Each tokenizer’s asset manager controls serve as the primary operational safeguard.

• These controls are designed to ensure compliance with Usual’s criteria and prevent unauthorized credit exposure.

• Tokenizers must use skilled, regulated asset managers operating under strict diversification and asset selection guidelines.

3) Third Line of Defense: Active Monitoring by Usual

• Usual independently monitors holdings within each accepted RWA tokenizer’s portfolio.

• Monitoring includes regular checks and audits to identify deviations from the credit policy.

• Both on-chain verification and off-chain review of fund reports are performed to confirm ongoing compliance.

• Any discrepancies are promptly escalated to the tokenizer and its asset managers for resolution.

Counterparty Risk Layers

In addition to the credit quality of underlying securities, Usual evaluates counterparty-related risks at three levels:

Layer	Risk	Mitigation
Tokenizer risk	Default or failure of the tokenization entity	Bankruptcy remote vehicles (BRVs), independent audits, periodic performance reviews; assets must be ring-fenced in the event of tokenizer bankruptcy
Fund manager risk	Poor investment decisions or policy violations	Only regulated fund managers with proven track records; regular assessment of investment decisions and compliance
Bank/custodian risk	Failure of a custodian or banking partner	Only highly rated institutions (e.g., BNY Mellon with AA- or higher); diversified banking relationships; contingency plans for institutional failures

The primary collateral provider, Hashnote USYC, illustrates these safeguards: its reverse repurchase agreements are conducted through the Depository Trust & Clearing Corporation (DTCC) (rated AA-), and custody is provided by BNY Mellon, one of the world’s largest and highest-rated custodians.

Insurance Fund Protection

In the unlikely event of collateral loss, Usual maintains a dedicated insurance fund to protect USD0 holders:

• The insurance fund is funded from a portion of collateral yield (approximately 20% accrual rate, set by the DAO).

• The fund is sized to absorb potential losses, with a maximum cap ranging from 0.33% to 5.33% of all USD0 in circulation, calibrated using historical stress tests.

• In a loss event, the insurance fund burns USD0 to increase the redeemable value per remaining token and restore the backing ratio.

• With an average bond duration of 0.33 years and a 5% coupon rate, the fund can be fully replenished in approximately 24 days.

Non-Compliance Management

If deviations from the credit risk policy are identified despite the mitigation framework, Usual applies the following escalation and remediation process:

• Decisive action: If a deviation persists after initial corrective steps, Usual escalates the issue in consultation with protocol governance to determine the appropriate response.

• Potential remedies include:

  • Immediately reducing exposure to the non-compliant collateral provider.

  • Removing the RWA tokenizer from the eligible collateral list.

  • Temporarily pausing minting via the non-compliant collateral type.

  • Activating the Counter Bank Run Mechanism if collateral value is impacted. This mechanism can pause the minting engine and route activity to the secondary market while remediation is underway.

• All remediation actions are subject to DAO governance, ensuring transparency and community oversight.

Historical Context

Usual’s zero-tolerance policy is informed by real-world precedent. During the March 2023 Silicon Valley Bank (SVB) crisis, Circle had approximately 8% of USDC reserves exposed to SVB, and USDC traded at an average of approximately $0.95 (a ~5% deviation from parity). Usual’s policy is designed to eliminate comparable exposure by requiring collateral invested exclusively in sovereign bonds and prohibiting exposure to commercial bank deposits, reducing the likelihood that USD0 could be affected by a similar event.

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This draft references updating “risk parameters, collateral requirements, and safety mechanisms from the KB.” No KB content was provided in this request, so the values and mechanisms above have been preserved as-is. If you share the relevant KB excerpts, I can align the document precisely while maintaining technical accuracy.