⚔️Risks of USDs as a Synthetic Dollar vs. Fiat and RWA-Backed Stablecoins

In creating USDs, Solenes provides a decentralized, synthetic dollar designed to minimize reliance on traditional banking systems and real-world assets (RWAs). However, like all financial products, USDs faces specific risks that users should understand. This section compares these risks with those associated with fiat- and RWA-backed stablecoins and details Solenes’s approach to risk management.

Risks in Existing Fiat and RWA-Backed Stablecoins

Fiat- and RWA-backed stablecoins, such as USDC or USDT, rely on collateral held within traditional financial institutions. While these stablecoins offer stability and ease of use, they come with significant drawbacks:

1. Custodial and Censorship Risk:

Fiat-backed stablecoins are vulnerable to risks associated with regulated bank accounts. Funds held in these accounts may be subject to freezes, regulatory interventions, or censorship.

2. Reliance on Banking Infrastructure:

These stablecoins depend on the traditional banking system to mint and redeem stablecoins, as demonstrated during the Silicon Valley Bank incident. When banks encounter operational issues, stablecoins may lose their peg due to delays or suspensions in redemption.

3. “Return-Free Risk”:

While fiat-backed stablecoin issuers earn interest on the collateral, they rarely pass these earnings to users. This results in “return-free risk,” where users assume the risk of depegging without receiving the benefits of the underlying yield.

4. Credit Exposure:

Stablecoin holders essentially hold an unsecured credit position with the stablecoin issuer and the underlying bank. If the issuer or bank fails, holders face potential losses on their holdings.

5. Dependence on Regulatory Compliance:

Fiat-backed stablecoins operate within the constraints of national regulations. This means their availability, usability, and even peg stability are subject to the regulatory environment, which can evolve and restrict access.

Risks Specific to USDs as a Synthetic Dollar

As a synthetic dollar, USDs avoids reliance on fiat banking systems or RWAs. However, this model presents its own unique risks, which Solenes actively mitigates through transparent strategies:

1. Funding Risk:

USDs relies on delta-neutral hedging, which involves short positions in derivatives. If funding rates become unfavorable for extended periods, the cost of maintaining these short positions could impact the protocol’s profitability.

● Mitigation: Solenes monitors funding rates and may adjust hedging strategies or allocate protocol reserves to offset costs during adverse conditions.

2. Liquidation Risk:

Price fluctuations in the collateral backing USDs may trigger liquidations if collateral values fall sharply. This can lead to losses and reduced peg stability.

● Mitigation: Solenes’s automated rebalancing mechanism minimizes the risk of liquidation, while real-time monitoring helps maintain appropriate collateral levels.

3. Custodial Risk:

Although Solenes uses non-US, off-exchange settlement providers to custody assets, this setup still involves custodial risk, especially if the provider experiences operational issues.

● Mitigation: Solenes diversifies across multiple custodial providers and uses providers with robust, bankruptcy-remote structures to protect user funds.

4. Exchange Failure Risk:

Solenes relies on centralized exchanges for derivatives positions to hedge collateral volatility. If an exchange fails or becomes inaccessible, USDs’ hedging effectiveness could be compromised.

● Mitigation: The protocol employs multiple exchanges to distribute exposure and implements a contingency strategy to adjust hedges or rebalance in case of exchange outages.

5. Collateral Risk:

Collateral backing USDs includes crypto assets, which may be volatile and susceptible to market risks. Sharp declines in collateral value can pose risks to USDs’ peg stability.

● Mitigation: Delta-neutral hedging offsets price volatility in collateral assets, while Solenes’s collateral mix is diversified to reduce exposure to any single asset’s risk.