# Liquidity Risk

### Definition

Liquidity risk is the risk that assets cannot be converted into cash quickly and at a reasonable price. It becomes acute when the protocol cannot meet investor redemption requests promptly without incurring material losses—especially when assets are illiquid or difficult to sell.

### Impact on USD0 Collateral

For Usual, liquidity risk directly affects the protocol’s ability to honor redemptions from **USD0 holders**, who are entitled to redeem their stablecoins for **$1 of collateral per USD0**. USD0 is backed by tokenized **Real World Assets (RWAs)**—primarily **US Treasury Bills** and **overnight reverse repurchase agreements**—that holders can select for redemption.

Because these assets are **not locked or staked in other protocols**, they should, in principle, be readily available for liquidation. However, liquidity constraints can still arise if a specific RWA becomes harder to sell or redeem. In such cases, Usual may need to:

* sell the asset on the secondary market, or
* redeem the asset directly through the tokenizer,

which requires reliable, fast, and operationally robust execution paths.

### Collateral Eligibility: Liquidity Requirements

To reduce liquidity risk at the source, Usual applies strict eligibility criteria to all accepted collateral:

* **Maximum duration**
  * The overall collateral portfolio must maintain a duration below **0.33 years** (\~4 months).
  * Individual RWAs must have a duration below **0.5 years**.
  * Collateral exceeding these thresholds is ineligible.
* **Maximum redemption window**
  * Only RWAs that can be redeemed or sold with minimal slippage within **5 days** are accepted.
* **Full collateralization**
  * Collateral must be fully collateralized, with **no leverage** and **no fractional-reserve structures**, avoiding liquidity amplification mechanisms typical in traditional banking.
* **Asset-type restrictions**
  * Investments are restricted exclusively to **US Treasuries**, **quasi-government debt**, or **cash**—the most liquid instruments in traditional finance.
  * **Corporate debt is strictly prohibited.**

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### Risk Monitoring and Management

Usual uses a **three-line-of-defense** framework to manage liquidity risk.

#### First Line of Defense (Prevention at Onboarding)

* **Initial selection criteria**
  * Only RWAs with inherently high liquidity are considered, and they must be redeemable or sellable with minimal slippage within **5 days**. This helps ensure USD0 collateral can be converted into cash quickly when needed.
* **Tokenizer due diligence**
  * Each RWA tokenizer undergoes a rigorous evaluation before approval, including:
    * redemption speed and process reliability,
    * settlement infrastructure (e.g., **T+0 to T+1 settlement into USDC or PYUSD** for the primary provider **Hashnote USYC**),
    * operational track record.
  * Redemption processes must be prompt and straightforward.
* **Zero FX risk policy**
  * Only **USD-denominated** assets are eligible, unless the position is **100% FX-hedged**, preventing currency conversion delays from compounding liquidity constraints.

#### Second Line of Defense (Portfolio Construction and Controls)

* **Liquidity diversification**
  * The portfolio is diversified across multiple RWA types and multiple tokenizer platforms to reduce reliance on any single market segment or redemption rail.
  * Current collateral providers include **Hashnote (USYC)**, **M0 Foundation (M)**, **Superstate (USTBL)**, and others—each with independent custody and redemption infrastructure.
* **Multi Collateral Controller**
  * The protocol uses a dynamic **Multi Collateral Controller** that continuously adjusts collateral-provider reward rates when allocations deviate from target (optimal) portfolio weights.
  * This incentivizes balanced contributions and reduces concentration risk.
  * Rebalancing is triggered when the **maximum deviation** between current and optimal weights exceeds a predefined threshold **ε**.
* **Counterparty diversification**
  * Different custodians (e.g., **BNY Mellon for Hashnote**), prime brokers, and service providers support each collateral type, reducing single-point-of-failure exposure.

#### Third Line of Defense (Ongoing Monitoring and Crisis Tools)

* **Continuous liquidity monitoring**
  * Liquidity conditions are monitored continuously and holdings may be adjusted as market conditions evolve.
  * Interest rates are tracked via a **daily weighted sum** with a **180-day rolling average**.
  * Alerts trigger if rates deviate more than:
    * **±5%** from the prior day, or
    * **±20%** from the **SOFR** benchmark.
* **Insurance fund**
  * The DAO maintains an insurance fund funded from approximately **20% of the yield** generated by USD0 collateral.
  * The fund is sized between **0.33% and 5.33%** of all USD0 in circulation, based on historical stress tests simulating extreme interest-rate increases beyond any recorded in the last **30 years**.
  * With an average bond duration of **0.33 years** and a **5% coupon rate**, the insurance fund can be replenished in approximately **24 days**.
* **Counter Bank Run Mechanism (CBR)**
  * In a severe liquidity crisis, the insurance fund can **burn USD0** to increase the **salvageable redemption value per token**.
  * If the salvageable value falls below **$1**, the DAO can temporarily **pause the minting engine** to prioritize re-pegging USD0 by directing all minting activity through the **secondary market**.
  * This mitigates “death spiral” dynamics where new minting dilutes already-stressed collateral backing.
* **Corrective measures**
  * If portfolio liquidity deteriorates beyond acceptable thresholds, the protocol can take corrective actions including:
    * duration reductions (selling or redeeming higher-duration RWAs),
    * temporary withdrawal restrictions, and
    * increased allocations to the insurance fund to rebuild liquidity buffers.

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> **Note:** The draft references updating parameters “from the KB.” No KB content was provided in this request, so all parameters and mechanisms above are preserved as written.