Introduction

Stablecoins have emerged as one of the most critical components within the decentralised finance (DeFi) ecosystem. Their ability to provide a digital asset that maintains a relatively stable value, typically pegged to a fiat currency such as the US dollar, has made them indispensable for both retail and institutional participants in the space.

According to data from DeFiLlama, as of January 2025, the total supply of stablecoins stands at approximately 217 billion USD. This represents a 19.8% increase from the previous peak of 181 billion USD recorded in 2021, demonstrating the sector’s substantial growth and its increasing importance in the broader financial landscape.

The stablecoin market is largely dominated by two key issuers: Tether (USDT) and USD Coin (USDC). Collectively, these two stablecoins account for approximately 90% of the total stablecoin supply, highlighting their dominant position within the industry. However, despite their widespread adoption, these centralised issuers do not provide any direct financial benefits to the users holding their stablecoins. Instead, their business model is designed to generate profits by investing the reserves backing these stablecoins into short-term U.S. Treasuries and other money market instruments, thereby earning sustainable yields.

The profitability of this model has been particularly evident in recent years. According to Tether’s H1 2024 financial report, the company generated over 5.2 billion USD in profit through the strategic investment of its reserves. This demonstrates the significant revenue potential embedded within centralised stablecoin issuance and reserve management, a benefit that remains largely unavailable to the end users of these assets.

Recognising this limitation, various attempts have been made to develop decentralised stablecoins that aim to redistribute value more equitably among users. Examples include DAI, crvUSD, and FRAX, which seek to introduce more decentralised mechanisms for issuance and reserve management. However, despite their innovative approaches, these alternative stablecoins have not been able to achieve the same level of market penetration as USDT and USDC. The dominance of centralised stablecoins persists, raising questions about the long-term viability and adoption of decentralised alternatives within the DeFi ecosystem.

Current issues in DeFi

The primary use case for USDT and USDC remains trading on both centralised and decentralised exchanges. Market participants generally understand that holding these stablecoins does not generate any inherent yield, as the issuers do not distribute interest earnings from their underlying reserves.

This absence of yield, however, has given rise to yield-bearing stablecoins, often referred to as “yieldcoins”. These stablecoins aim to provide users with a mechanism to earn passive income by externalising the interest accrued from their backing assets. The most prominent example in recent times has been Ethena’s USDe, which experienced exponential growth, expanding from 85 million USD to 5.8 billion USD in 2024.

Yieldcoins operate by distributing interest earnings, primarily to token holders. This includes users who supply these assets to lending protocols such as AAVE, where they can earn additional yield. As a result, a popular leveraged yield strategy has emerged within the DeFi space. This strategy involves supplying yieldcoins as collateral, borrowing non-yielding stablecoins against them, and then “looping” this position to capitalise on the difference in interest rates (i.e. a form of carry trade).

While profitable in certain market conditions, this practice has introduced significant inefficiencies and imbalances within the DeFi lending ecosystem. One of the primary issues is that the growing demand for leveraged positions has resulted in rising borrowing rates on non-yielding stablecoins. At the same time, the large supplies of yieldcoins in lending protocols remain underutilised, as these assets are not being heavily borrowed. The reason for this is that any debt denominated in yield-bearing stablecoins would inherently increase over time due to the compounding effect of intrinsic yield on top of borrowing costs.

As a consequence, lending protocols suffer from structural inefficiencies, particularly in terms of utilisation rates. The demand for borrowing non-yielding stablecoins has increased, while the supply-side liquidity of yieldcoins remains underused, creating an imbalance that disadvantages the sell-side participants (borrowers) in lending markets.

To further illustrate this phenomenon, the depicted supply/demand matrix for USDC vs. sUSDe (Staked USDe) during DeFi expansion and contraction cycles provides deeper insights into these inefficiencies.

A crucial factor in this comparison is that Circle does not externalise interest earnings from its reserves to USDC holders. As a result, USDC does not generate yield unless it is actively supplied to a lending protocol or deployed in a yield-generating strategy. In contrast, if a yieldcoin such as sUSDe was used as the borrowing medium instead of USDC, its intrinsic yield would compound as additional debt, making it an impractical borrowing instrument. Due to this, most users prefer to borrow non-yielding stablecoins such as USDC rather than yieldcoins, further reinforcing the structural imbalances within DeFi lending markets.

Introducing dTRINITY

In response to the inefficiencies and imbalances outlined above, dTRINITY introduces an innovative lending protocol designed to subsidise borrowing costs using yieldcoins. By fundamentally rethinking how borrowing incentives are structured, dTRINITY aims to create a more efficient lending market that enhances utilisation and improves capital efficiency.

As its name implies, dTRINITY consists of three primary components:

dUSD – a stablecoin that serves as the protocol’s key medium of exchange and borrowable asset.
dLEND – a lending platform that integrates yield-bearing mechanics to optimise borrowing dynamics.
External Liquidity Pools - decentralised exchange pools where dUSD can be swapped with other assets.

This design is also inspired by Frax’s “DeFi Trinity” framework, which is where the name comes from. For a clearer understanding of how dTRINITY functions, refer to the accompanying illustrative graphic below.

The primary innovation that differentiates dUSD and dLEND from existing stablecoins and lending platforms lies in the way yield is distributed. Unlike protocols such as sUSDe or sDAI, where the intrinsic yield is externalised to stablecoin holders, dTRINITY redirects yield to borrowers instead. This fundamental shift naturally stimulates borrowing demand and increases utilisation rates, which in turn raises yields and fees for lenders and liquidity providers (LPs), creating a more sustainable ecosystem.

The borrowing rate mechanism within dLEND is based on the AAVE V3 interest rate model. However, what sets it apart is that the yield generated from dUSD reserves is directly passed on to borrowers, effectively subsidising their borrowing costs. This can be visualised in the animated graph below, which illustrates how these subsidies impact borrowing rates.

One of the most notable effects of this subsidy mechanism is the occurrence of negative APRs, meaning that users are paid to borrow (net of subsidies) instead of incurring interest costs. Additionally, at lower utilisation rates, the net APR becomes significantly negative, as fewer borrowers receive disproportionately high subsidies since they are not required to share the benefits with a larger borrowing pool.

While dLEND, as a novel lending primitive, warrants its own in-depth exploration, this article will primarily focus on dUSD and its functionality.

Deconstructing dUSD

dUSD is a decentralised stablecoin designed to maintain a stable value while being fully backed by an on-chain reserve consisting of a diversified pool of USD stablecoins and yield-bearing stablecoins (yieldcoins). This structure ensures that every unit of dUSD maintains a robust collateral base while benefiting from the inherent yield generated by certain backing assets.

Each dUSD is backed by at least 1 USD worth of collateral, ensuring that its peg remains well-supported under all market conditions. The design prioritises transparency and security, as all collateral assets remain fully verifiable on-chain.

A key feature of dUSD is that it can be permissionlessly minted, allowing users to generate new dUSD as long as they provide sufficient collateral. However, at this stage, dUSD cannot yet be redeemed for its underlying assets by default. The implications of this design choice will be examined in greater detail later in this article.

To further enhance stability and mitigate risks, dTRINITY plans to employ multiple price oracles to ensure that dUSD is always correctly collateralised. This oracle mechanism is particularly noteworthy when dealing with yieldcoins, as it does not simply rely on their market price but instead accounts for their underlying backing to assess their true value accurately.

Additionally, if a stablecoin that serves as part of dUSD’s collateral has an intrinsic value exceeding 1 USD, dUSD’s oracles will cap its valuation to exactly 1 USD, while disregarding temporary market fluctuations. These mechanisms ensure that dUSD’s collateral is accurately valued and resistant to price distortions, maintaining stability and mitigating under-collateralisation risks.

dTRINITY’s Stability Mechanisms

The price stability of dUSD is maintained through a carefully designed system that does not rely on direct redemption by users, similar to FRAX and the US Dollar. This approach allows dTRINITY to maximise the yield generated from its collateral base, ensuring that borrowing subsidies remain well-funded. However, since users cannot redeem dUSD for its underlying assets, alternative mechanisms are required to maintain its peg on the secondary market. The stability of dUSD is primarily upheld through two key forces: market-driven arbitrage by borrowers and traders/LPs, and active market operations conducted by dTRINITY itself, similar to the Fed’s open market operations. Let’s first analyse the latter.

To manage fluctuations in dUSD’s price, dTRINITY employs two types of open market operations, each designed to address different pricing scenarios. When the price of dUSD falls below its intended one-dollar peg, Stability Market Operations (SMOs) are activated to reduce the supply of dUSD circulating in the market. This is particularly crucial, as a downward depeg is often perceived as the most significant risk for stablecoin users, given the potential for loss of confidence and capital. If dUSD is trading at a discount on decentralised exchanges such as Curve Finance, dTRINITY intervenes by deploying its reserves to repurchase and effectively remove excess dUSD from the market. This process not only restores the peg by restricting supply but also generates arbitrage profits, which are reinvested into dUSD’s collateral reserves, further strengthening its financial stability.

In contrast, when dUSD trades above its peg, Algorithmic Market Operations (AMOs) are implemented to expand its supply in a controlled manner. This is achieved by issuing additional dUSD tokens into designated liquidity pools, thereby alleviating excess buying pressure and restoring equilibrium. Unlike traditional stablecoin expansions, where excessive issuance could lead to under-collateralisation, dTRINITY ensures that these additional tokens are supported by a sound reserve strategy, which can be seen in the balance sheet graph below. The process of increasing dUSD supply when demand is high also allows the protocol to accumulate new reserves, further improving the collateralisation ratio. Additionally, arbitrageurs benefit from these market conditions by selling dUSD at a premium and reinvesting the profits, which indirectly contributes to a more robust collateral base. This dynamic allows dUSD to respond rapidly to increased borrowing demand, particularly in scenarios where traders swap other assets for dUSD in order to repay outstanding debt.

Through the combination of SMOs and AMOs, dUSD maintains its stability while ensuring long-term sustainability. The ability to contract supply when its price declines and expand supply when demand surges creates a balanced mechanism that mitigates volatility without compromising the integrity of the underlying reserves. Moreover, this approach strengthens the protocol’s ability to fund its unique borrowing subsidy model, ensuring that lending markets remain efficient and attractive to participants.

User-Influenced Stability Mechanisms

The stability of dUSD is not only upheld by dTRINITY’s direct interventions through SMOs and AMOs but also by market-driven arbitrage opportunities that incentivise rational behaviour from borrowers, traders, and market makers. The effectiveness of this system hinges on the ability of market participants to exploit arbitrage opportunities when dUSD deviates from its peg, reinforcing its stability through economic incentives. Borrowers, in particular, play a crucial role in maintaining equilibrium. When dUSD trades below its one-dollar peg, they are encouraged to purchase it at a discount on the open market to repay their outstanding debt, thereby reducing its circulating supply and exerting upward pressure on its price. Conversely, when dUSD trades above its peg, rational users would be incentivised to borrow more dUSD and sell it at a premium, increasing supply and counteracting excessive demand.

Market makers also contribute significantly to dUSD’s stability by attempting to front-run dTRINITY’s SMO and AMO operations. These traders recognise that dTRINITY’s interventions will ultimately restore dUSD’s peg, creating a predictable arbitrage opportunity. As a result, they strategically position themselves to capture profits before the protocol executes its corrective actions. This additional layer of arbitrage reinforces the peg and ensures that deviations from one dollar are swiftly addressed by both individual traders and institutional liquidity providers. However, the effectiveness of these market-driven forces ultimately depends on the assumption that dTRINITY is both trustworthy and consistent in executing its SMO and AMO operations. If participants lose confidence in the protocol’s ability or willingness to act in a timely manner, the incentive structure weakens, and deviations from the peg may persist longer than anticipated.

To better understand the dynamics between users and dTRINITY, consider a simplified scenario in which the price of dUSD has fallen to 90 cents, representing a 10% deviation from its intended peg. In this case, an arbitrage opportunity exists where users can purchase dUSD at a discount and later sell it at full value once the peg is restored, capturing a 10% profit. From this scenario, a payoff matrix can be constructed, illustrating how both dTRINITY and market participants are motivated to act. dTRINITY has a strong incentive to execute an SMO at this price level, as doing so maximises arbitrage profits while simultaneously reinforcing confidence in the protocol’s ability to maintain stability through SMOs. Likewise, users are encouraged to buy dUSD below its peg, both to capitalise on the arbitrage opportunity and to protect the value of their assets within the ecosystem. This would also lead to an increase in expectation that users will defend the peg and that SMOs are not necessary, since the markets will self-regulate. This interplay creates a Nash equilibrium in which both parties act in alignment, effectively sharing the arbitrage profits and ensuring that dUSD’s peg is consistently defended by both parties.

However, this theoretical framework operates under the assumption that both users and dTRINITY execute these actions simultaneously, which is not always the case in reality. Historical price data suggests that arbitrage participants and the protocol tend to act at different times, leading to a more complex price recovery process. This introduces the concept of a critical price level, denoted as p_crit, at which dTRINITY is expected to intervene with an SMO to restore the peg. Market participants, aware of this threshold, are incentivised to front-run dTRINITY by purchasing dUSD just before it reaches pcritpcrit, thereby maximising their arbitrage profits. This behaviour can be visualised in the accompanying graph, which illustrates how traders strategically position themselves in anticipation of dTRINITY’s intervention.

A potential inefficiency arises if p_crit is widely known, as users would have a clear incentive to allow dUSD’s price to drop to that level before executing their trades. This could introduce unnecessary volatility and delay the restoration of the peg, as traders seek to optimise their individual profits rather than contributing to market stability at higher price levels. To counteract this behaviour, dTRINITY can introduce an element of unpredictability by randomising the interval at which it conducts SMOs and varying p_crit over time. If users are uncertain about the exact threshold at which dTRINITY will intervene, they will be incentivised to keep dUSD’s price as close to one dollar as possible to avoid missing out on arbitrage opportunities. By engineering a system in which stability is the most rational outcome for all participants, dTRINITY ensures that dUSD remains well-anchored to its peg, reinforcing confidence in both its mechanism and its long-term viability.

Conclusion

Ultimately, dTRINITY’s approach to stablecoin stability represents a significant evolution in decentralised finance. By integrating market incentives with protocol-driven interventions, dUSD achieves a level of resilience that is difficult to replicate in traditional models. Its ability to dynamically manage supply, reinforce collateralisation, and align incentives between the protocol and its users positions it as a pioneering force in decentralised stablecoin design. As the DeFi ecosystem continues to mature, dTRINITY’s peg maintenance mechanisms provide a scalable and sustainable solution to one of the most pressing challenges in decentralised finance: the creation of a truly stable, decentralised, and capital-efficient stablecoin.

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Deconstructing dUSD: The Stablecoin That Pays You to Borrow