# Counterparty Risk Counterparty risk is a core dimension of Usual Protocol’s risk management framework. Because **USD0** is backed by tokenized **Real-World Assets (RWAs)** held through external providers, the integrity, operational resilience, and solvency of each entity in the collateral chain directly affect the safety of the stablecoin and its holders. *** ## Definition **Counterparty risk** is the possibility that a counterparty (e.g., a financial institution, service provider, or other entity) fails to meet its contractual obligations, defaults on its commitments, or becomes insolvent. In Usual Protocol, key counterparties form a **three-layer chain**: * **Tokenizer** — creates and manages the on-chain token representation of the underlying RWA (e.g., **Hashnote** for **USYC**, **Superstate** for **USTBL**). * **Fund manager** — manages the underlying investment portfolio (e.g., US Treasury Bills, reverse repos, government securities). This may be the tokenizer itself or a dependent party. * **Banks and custodians** — hold, settle, safeguard, and clear the underlying assets (e.g., **BNY Mellon** for Hashnote custody, **DTCC** for clearing). *** ## Impact on Usual’s Collateral USD0 collateral can be impaired if any counterparty in the RWA chain fails. The impact depends on where the failure occurs: * **Tokenizer failure**\ May prevent or delay minting, redemption, or liquidation of the tokenized RWA. If the tokenizer’s operations or technology are compromised, access to collateral can be disrupted. * **Fund manager default or insolvency**\ Can lead to portfolio losses that reduce the value of the collateral pool. Poor investment decisions, unauthorized leverage, or fraud could erode the assets backing USD0. * **Banking or custodial failure**\ Can restrict access to funds or lead to direct losses during liquidity crises or insolvencies—historically illustrated by **Lehman Brothers (2008)** and **Silicon Valley Bank (2023)**. The SVB event caused Circle’s USDC to depeg to approximately **$0.95** due to **8%** of reserves being held at the failed bank. Usual’s risk policy is explicitly designed to avoid such exposure. *** ## Collateral Eligibility Requirements Before any counterparty is accepted into Usual’s collateral system, it must pass a rigorous due diligence process. The protocol enforces strict eligibility criteria across **all three layers** (tokenizer, fund manager, and banking/custody): | Requirement | Standard | | -------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------- | | **Full collateralization** | **100% collateralized** — no leverage, no fractional reserves. Excludes any exposure to fractional reserve banking or leveraged positions. | | **Asset quality** | Investments restricted exclusively to **US Treasuries**, quasi-government debt, reverse repos, or cash. **Corporate debt is strictly prohibited.** | | **Duration limit** | Individual RWA duration must be **< 0.5 years**; portfolio average duration must not exceed **0.33 years** (\~4 months). | | **FX risk** | **Zero tolerance** — only USD-denominated assets or positions that are **100% FX-hedged**. | | **Credit risk** | **Zero tolerance** — no corporate credit exposure permitted under any circumstances. | | **Liquidity** | RWAs must be redeemable or sellable with minimal slippage within a maximum of **5 days**. | | **Transparency** | Collateral must be verifiable on-chain in real time and provide high transparency off-chain through frequent public financial audits. | | **Regulatory compliance** | Tokenizers must be fully licensed and regulated under appropriate financial authorities (e.g., **CIMA**, **CFTC**). | | **Asset protection** | Assets must be ring-fenced in a **bankruptcy remote vehicle (BRV)** in the event of the tokenizer’s insolvency. | *** ## Risk Monitoring and Management Usual applies a comprehensive, multi-layered approach to counterparty risk using a **three-line-of-mitigation** model. Each line defines (1) criteria, (2) monitoring, and (3) contingency actions across each counterparty layer. ### First Line of Mitigation: Clear Counterparty Criteria * **Tokenizer** * Must operate via **bankruptcy remote vehicles (BRVs)**. * Must demonstrate robust operations and financial stability, verified through independent audits. * Must undergo thorough technology audits (smart contract audits and operational security audits). * Only experienced tokenizers with proven track records are eligible. * **Fund manager** * Must have a demonstrated track record managing Treasury and sovereign debt portfolios. * Must be regulated under appropriate financial authorities. * Must follow strict guidelines that prohibit leverage, corporate debt, and FX-unhedged positions. * Must maintain skilled and compliant asset management teams. * **Banks and custodians** * Must be **highly rated** institutions demonstrating strong risk management, compliance, and capital adequacy (e.g., **BNY Mellon** for institutional-grade custody; **DTCC** with an **AA-** credit rating). * Must maintain **diversified banking relationships** to reduce concentration risk at any single institution. ### Second Line of Mitigation: Ongoing Monitoring and Compliance Checks * **Tokenizer** * Periodic audits, security reviews, and performance assessments to ensure continued compliance with technical, regulatory, and operational requirements. * Dual-layer monitoring: both the tokenizer and Usual independently monitor holdings for compliance with the risk policy. * **Fund manager** * Regular review of investment decisions, risk exposure, duration profiles, and portfolio composition to ensure alignment with Usual’s risk appetite. * The protocol monitors the **weighted average duration** of reserve assets, with: * a tolerance threshold of **0.25 years** for minor fluctuations; and * alerts triggered when the **rolling 180-day weighted average** deviates more than **±5%** from the previous day or more than **±20%** from the **SOFR** benchmark. * **Banks and custodians** * Continuous monitoring of partner health and stability, including credit ratings, risk exposure, regulatory standing, and liquidity position. * Any deterioration triggers escalation procedures. ### Third Line of Mitigation: Contingency Plans and Corrective Actions * **Tokenizer** * Pre-defined contingency plans for tokenizer failure, including alternative redemption paths, collateral liquidation, and migration to backup collateral providers. * The DAO can remove underperforming or at-risk collateral types via governance vote. * **Fund manager** * Mechanisms to switch fund management services quickly to minimize disruption. * Recovery procedures and asset-transfer protocols are documented and tested. * **Banks and custodians** * Custody and banking are **diversified across multiple institutions** to mitigate single-institution failure risk. * Contingency plans include rapid asset reallocation and alternative settlement arrangements. * Historical failures (Lehman Brothers, Silicon Valley Bank) are explicitly treated as scenarios the risk policy is designed to withstand. *** ## Insurance Fund Protection To further mitigate counterparty-related collateral losses, Usual maintains a dedicated **insurance fund** per **Liquid Deposit Token (LDT)**: | Parameter | Value | | ---------------------- | ------------------------------------------------------------------------------------------------------ | | **Funding source** | A portion of yield generated by the LDT (insurance accrual rate set by the DAO, approximately **20%**) | | **Maximum cap** | Between **0.33% and 5.33%** of all USD0 LDTs, determined by historical stress testing (VAR analysis) | | **Replenishment time** | Approximately **24 days** (at **0.33-year** average duration and **5%** coupon rate) | | **Mechanism** | Burns LDT held in the insurance fund to increase the salvageable redemption value per LDT | The insurance fund cap is calibrated against extreme historical scenarios, including: * A **75 bps** interest rate rise over a two-week period (observed in 2022) * A **100 bps** increase over a one-month period (observed in 2022) * SVB-type counterparty exposure resulting in up to a **5% depeg** (as experienced by USDC in March 2023) Given the portfolio’s maximum average duration of **0.33 years**, even these extreme scenarios would temporarily reduce collateral value by approximately **0.33%**. ### Counter Bank Run Mechanism (CBR) The **Counter Bank Run Mechanism (CBR)** adjusts the salvageable redemption value using the insurance fund: $$ S\_{LDT} = \min \left( \frac{\sum\_{i=1}^n P\_{Collateral\_i} \times C\_{Collateral\_i}}{Supply\_{LDT} - Insurance\_{LDT}},\ F\_{LDT} \right) $$ If the salvageable redemption value falls below 1, the DAO can temporarily pause the minting engine and direct minting through the secondary market to focus on re-pegging. *** ## Collateral Diversification as Risk Mitigation Counterparty risk is further reduced through **multi-provider collateral diversification**. USD0 is backed by assets from multiple tokenizers, custodians, and service providers, reducing single points of failure: | Collateral | Tokenizer | Key Custodian / Counterparty | | ---------- | ------------- | ---------------------------------------------------------------------- | | **USYC** | Hashnote | BNY Mellon (custody), DTCC (clearing, AA- rated), Marex (prime broker) | | **M** | M0 Foundation | Independent custody and administration | | **USTBL** | Superstate | SEC-regulated, US Treasury Bills | | **USDC** | Circle | Indirect minting collateral via Collateral Providers | The **Multi Collateral Controller** dynamically manages portfolio composition across providers by: * continuously adjusting reward rates to incentivize balanced collateral contributions; and * triggering rebalancing when the maximum deviation between actual and optimal portfolio weights exceeds a predefined threshold. *** ## Community Governance of Counterparty Exposure Counterparty and collateral exposure is governed by the community through **USUAL token governance**. Holders can vote on: * Adding or removing collateral types and their associated counterparties * Setting maximum exposure limits per collateral provider * Adjusting risk parameters based on evolving market conditions * Responding to counterparty deterioration or emerging risks This governance layer keeps counterparty-risk decisions transparent, community-driven, and responsive to changing conditions rather than controlled by a single corporate entity. *** --- # Agent Instructions: Querying This Documentation If you need additional information that is not directly available in this page, you can query the documentation dynamically by asking a question. Perform an HTTP GET request on the current page URL with the `ask` query parameter: ``` GET https://docs.usual.money/resources-and-ecosystem/risk-policy/third-party-risk/counterparty-risk.md?ask= ``` The question should be specific, self-contained, and written in natural language. 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