Insurance Fund

Rationale

The value of the collateral reserves backing USD0 can fluctuate with changes in interest rates. US Treasury Bills and government securities are generally considered risk-free assets and are typically repaid at par at maturity. However, when interest rates rise, the mark-to-market value of these instruments can temporarily decline, creating a short window of undercollateralization before the bonds mature. Over time, this temporary gap is naturally offset by the daily interest income accrued on the underlying collateral.

In the unlikely event of a mass redemption scenario—where many users redeem USD0 simultaneously—combined with a temporary dip in collateral value caused by market movements, it may not be possible to redeem 1 USD0 for exactly $1 worth of collateral at that moment. To mitigate this tail risk, Usual implements several protective measures:

• Short-duration collateral: As defined in the risk policy, all collateral must maintain a portfolio average duration below 0.33 years (~4 months), with individual RWAs capped at 0.5 years. This materially limits exposure to interest-rate fluctuations.

• Zero tolerance for credit and FX risk: Only US Treasuries, quasi-government debt, or cash are accepted—no corporate debt and no unhedged foreign-currency exposure.

• Segregated insurance fund: A dedicated on-chain fund designed to absorb potential undercollateralization events, acting as a buffer to protect USD0’s 1:1 peg.

Note: If any risk parameters, collateral requirements, or safety mechanisms have been updated in the knowledge base (KB), reflect those latest values here.

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Calculation and insurance fund calibration

To ensure robustness against severe financial shocks, Usual conducted stress tests simulating extreme interest-rate increases exceeding anything recorded in the last 30 years.

Historically, the most significant short-term increases in 6-month yields were:

• +75 bps over a two-week period (observed in 2022)

• +100 bps over a one-month period (observed in 2022)

Given a maximum portfolio average duration of 0.33 years, a recurrence of these historical extremes could temporarily reduce collateral value by approximately 0.33%. This impact primarily affects mark-to-market valuation for a few months, until the bonds mature at par.

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Salvageable redemption value

The insurance fund operates through the Counter Bank Run Mechanism (CBR). Under the CBR, the protocol can increase the per-token backing ratio by burning USD0 held in the insurance fund, thereby reducing circulating supply relative to the collateral value.

The salvageable redemption value is calculated as:

$$S_{LDT} = \min \left( \frac{\sum_{i=1}^n P_{Collateral_i} \times C_{Collateral_i}}{Supply_{LDT} - Insurance_{LDT}}, F_{LDT} \right)$$

Where:

Variable	Description
$P_{Collateral_i} \times C_{Collateral_i}$	Total value of collateral type $i$
$Supply_{LDT}$	Floating supply of USD0
$Insurance_{LDT}$	USD0 set aside by the DAO for the insurance fund
$F_{LDT}$	Intended fair price of USD0 (i.e., $1.00)

By burning USD0 from the insurance fund (i.e., reducing the denominator), the protocol increases the redemption value per remaining USD0 in circulation, supporting restoration of the peg.

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Insurance fund sizing

The DAO sets a maximum insurance fund cap based on historical Value-at-Risk (VAR) analysis. The cap ranges from 0.33% to 5.33% of all USD0 in circulation:

Scenario	Cap range	Basis
Interest-rate shock only	~0.33%	Worst-case +100 bps move with 0.33-year duration
Combined with counterparty exposure	Up to 5.33%	Includes SVB-type events (referencing the ~5% USDC depeg in March 2023 when Circle had 8% exposure to Silicon Valley Bank)

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Setting and maintaining the insurance fund

The insurance fund is sized to cover tail-risk events. Operationally, the goal is to maintain the fund above the calculated minimum requirement.

Funding source

The insurance fund is funded using a portion of the yield generated by USD0’s underlying collateral. The DAO sets an insurance accrual rate—approximately 20% of collateral yield—which is directed into the fund on an ongoing basis.

Replenishment speed

Protocol revenue is allocated to replenish the insurance fund.

Example: With an average bond duration of 0.33 years and a coupon rate of 5%, it would take approximately 24 days to replenish the insurance fund to cover potential losses from a worst-case interest-rate shock.

Emergency measures

If the salvageable redemption value falls below 1, the DAO can take additional defensive actions:

1. Temporarily pause the minting engine to focus on re-pegging USD0 using existing supply.

2. Route minting activity through the secondary market only (no new collateral accepted until the peg is restored).

3. Deploy the insurance fund to burn USD0 and restore the per-token backing ratio.

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Monitoring the insurance fund

To ensure adequate coverage, the insurance fund size is periodically computed, taking into account the duration of underlying risk-weighted assets and current market conditions. Key monitoring parameters include:

• Portfolio duration: Continuously tracked to ensure the weighted average remains below 0.33 years, with a 0.25-year tolerance for minor fluctuations.

• Interest-rate monitoring: A 180-day rolling weighted average of collateral rates is maintained. Alerts trigger when the rolling average deviates:

  • more than ±5% from the previous day, or

  • more than ±20% from the SOFR benchmark.

• Fund adequacy: Regular comparison of the insurance fund balance against the VAR-derived minimum requirement.

Funding and top-ups are facilitated via a smart contract, allowing the DAO to manage the flow of USD0 from DAO reserves if existing funds are insufficient. This on-chain mechanism ensures transparency: anyone can verify the current size and adequacy of the insurance fund at any time.