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.