Risk Factors
Last Revised on August 23, 2024
The following risk factors highlight some core risks associated with rUSD, srUSD and trUSD (the “Protocol Tokens”). The list of risk factors set forth below does not purport to be a complete enumeration or explanation of the risks involved in the purchase of the Protocol Tokens.
Risks Regarding the Reserves
No guarantee of rUSD, srUSD or trUSD redeemability. Subject to the limitations set forth in the Terms of Service for the Protocol (the “Terms of Service”), (i) in order to mint rUSD users must deposit one USDC for every rUSD that is to be minted and when rUSD are transferred to the Protocol to be redeemed, such redemption will be at a rate of one USDC per one rUSD, less any fees where applicable; (ii) in order to mint srUSD or trUSD users must deposit one rUSD for every srUSD or trUSD that is to be minted and when srUSD or trUSD are transferred to the Protocol to be redeemed, at the applicable redemption period, such redemption will be at a rate of one rUSDC per one srUSD or trUSD, respectively, less any fees where applicable.
However, there is no guarantee that the Reserves will be sufficient to enable holders of Protocol Tokens to redeem all such Protocol Tokens on issue for USDC on a 1:1 basis.
The intent of the developers of the Protocol is that USDC used to mint Protocol Tokens will be deployed in one or more digital or real-world assets as discussed further below (such assets, collectively, the “Reserves”). There is no guarantee that the value of the Reserves will always exceed the aggregate USDC redemption value of all then outstanding Protocol Tokens, in part due to the risks associated with the Reserves discussed below, or that the Protocol will otherwise have the ability to satisfy all requests to redeem rUSD (or srUSD or trUSD) for USDC on a 1:1 basis. Moreover, trUSDs can only be redeemed in accordance with their maturity schedule; thus the risk of insufficient Reserves may be greater during the open periods for trUSD redemptions.
In addition, there is no guarantee that the price of one Protocol Stablecoin will always equal one USDC or one U.S. Dollar ($1) across all platforms and when trading in the secondary market. Due to a variety of factors outside of the control of any one party, the value of the Protocol Tokens, including on both centralized and decentralized cryptocurrency exchange platforms and protocols, may fluctuate above or below one USDC or $1. The Protocol and the parties involved in the development and operation of the Protocol cannot control how third parties or secondary markets value the Protocol Tokens and are not responsible for any losses or other issues that may result from fluctuations in the value of Protocol Tokens.
Risks regarding the Reserves. Users’ ability to continue to redeem rUSD (and consequently srUSD or trUSD) on a 1:1 basis for USDC may be materially and adversely impacted by risks associated with the Reserves. These risks include but are not limited to:
General Risks Relating to Investments. The Protocol will initially deploy the Reserves to invest in certain funds managed by third-party asset managers (“Asset Managers”). The initial Asset Manager will be Fortunafi Capital Management LLC, although following the introduction of decentralized Protocol governance, the allocation of the Reserves will be determined through governance. The Asset Managers will invest and deploy the Reserves using one or more trading or investment strategies (each, a “Trading Strategy”). All trading and investment activity involves a high degree of risk, including the risk that the entire principal amount invested may be lost. No guarantee or representation is made that the Trading Strategies will be successful. In the event that the Trading Strategies are unsuccessful, or certain risks associated with such Trading Strategies materialize or are realized, the Reserves may be adversely impacted or lost, which may adversely impact or compromise your ability to redeem Protocol Tokens on a 1:1 basis for USDC. As a result, the value of your Protocol Tokens may be materially and adversely impacted, up to and including a loss of all or substantially all amounts invested.
Risks Related to Redemption Volume. While the intent of the developers of the Protocol is to ensure that sufficient USDC remain available to fulfill all redemption requests, in circumstances where the Protocol is experiencing high volumes of redemption requests, the interests in the funds in which the Reserves are invested may need to be redeemed. While redemptions can be automatically sent for tokenized fund interests, if an Asset Manager needs to liquidate offchain positions, constraints on its ability to do so may adversely impact your ability to redeem Protocol Tokens in a timely manner. Moreover, increased volumes of redemption requests may also result in decreases in the value at which Protocol Tokens trade in secondary markets, which may form a feedback loop and contribute to further redemption requests. For example, if increased redemptions drive a decrease in the secondary market trading value of rUSD which in turn drives further redemption requests. Such feedback loops may further materially and adversely impact or compromise your ability redeem rUSD on a 1:1 basis for USDC and/or the value of your Protocol Tokens, up to and including a loss of all or substantially all value and principal invested. While it is intended that the Reserves will be invested so that Protocol Tokens can always be redeemed on a 1:1 basis for USDC, including through the use of the peg stability module which will hold USDC for redemptions, there is no guarantee that the USDC in the peg stability module will be sufficient to fulfill all outstanding requests. In addition, it is possible that the total value of the Reserves will be insufficient for the redemption of all outstanding Protocol Tokens. If the Reserves are not sufficient (either in USDC in the peg stability module, or in general) to redeem outstanding Protocol Tokens, then the Protocol will take efforts to increase reserves., but such efforts may not be successful.
Trading, Investment, and Market Risk. The Protocol was implemented to invest and deploy the Reserves using one or more trading strategies, including trading strategies utilizing derivatives and other sophisticated complex financial instruments. As a result of such trading strategies, the Reserves may be subject to a range of trading, investment, and market related risks as discussed in more detail below. These risks may materially and adversely impact your ability to redeem Protocol Tokens and could also materially and adversely detract from the value of your Protocol Tokens, up to and including potential loss of the entire value of your investment.
Unsecured Deposit. The Protocol Tokens are not subject to any deposit insurance protection or any similar government or private industry deposit guaranty regimes. If one of the funds managed by the Asset Managers were to become insolvent, the Protocol would not have a secured claim against that fund, and holders of Protocol Tokens may not be able to recover their assets. In addition, because investment funds generally require a legal entity to be a subscriber to their fund, the nominal subscriber to the funds will be Reservoir Foundation, however the Reservoir Foundation has no legal or contractual relationship with the Protocol, the holders of Protocol Tokens, or the holders of Protocol Governance Tokens. Although the fund interests themselves are tokenized, there is a possibility that creditors of the Reservoir Foundation will be able to make claims against the tokenized fund interests that form part of the Reserves, which could cause the Reserves to be depleted such that not all Protocol Tokens can be redeemed for USDC on a 1:1 basis.
Derivatives Based Trading Strategies. The Trading Strategies employed by the funds in which the Reserves are invested may involve the use of derivatives such as futures contracts. Derivatives are financial contracts whose value depends on, or is derived from, another underlying product or asset. Trading in derivatives involves additional and special risks that may be different to or greater than the risks associated with investing in the relevant underlying product or asset directly. Risks associated with derivatives and futures trading include but are not limited to the following:
Volatility. Derivatives and futures markets are highly volatile. The pricing and valuation of derivatives and futures are influenced by, among other things: changing supply and demand relationships, governmental actions, interest rates and other macroeconomic factors, national and international political and economic events, and prevailing psychological characteristics of the marketplace. There is no guarantee that the Asset Managers will engage in profitable derivatives trades or that the Asset Managers will not incur substantial losses in engaging in derivatives or futures trading in deploying the capital invested in the funds, including the Reserves.
Leverage. Derivatives and futures trading is typically leveraged, and thus may require a margin deposit of only a relatively small percentage in comparison with the total potential position value or liability under the relevant derivatives contract. As a result, a relatively small price movement in the underlying product or asset may result in a loss to the fund equal to or substantially greater than the amount of the deposit. Combined with the volatility of derivatives prices, the leveraged nature of derivatives trading can cause unpredictable, large and sudden losses of capital.
Liquidity. Derivatives positions may not be liquid and/or may only be able to be closed out on the exchange on which they were entered into or through a linked exchange. Derivatives exchanges may limit fluctuations in certain derivatives contract prices during a single day by regulations referred to as “daily price fluctuation limits” or “daily limits”. Once the price for a particular contract has increased or decreased by an amount equal to the “daily limit”, positions can be neither taken nor liquidated unless traders are willing to effect trades at or within the limit. Such illiquidity or transaction limits could prevent the Asset Managers from liquidating unfavorable positions, which could cause losses to the Reserves base and impair your ability to redeem Protocol Tokens.
Imperfect hedging or management of market exposure as part of derivatives trading strategies could result in market or price exposure that has adverse impacts on the success of the funds in which the Reserves are invested, and consequently in the value of the Reserves. In such event, your ability to redeem Protocol Tokens on a 1:1 basis for USDC may be adversely impacted or compromised and, as a result, the value of your Protocol Tokens may be materially and adversely impacted, up to and including a loss of all or substantially all amounts invested.
Risks Relating to the Protocol Generally
Risks Relating to the Launch of the Protocol. The Protocol is currently in a beta state, and remains subject to further development and modification. There can be no assurance that it will function as intended or as described on the Protocol’s website or in other communications or will be maintained and developed according to current plans. There can be no assurance that you will be able to utilize the Protocol or the Protocol Tokens in any particular way. Accordingly, the Protocol and the Protocol Tokens could have limited or no utility.
Risks Relating to Tokens’ Value or Use in the Future. Your ability to utilize the Protocol Tokens in the future is contingent upon numerous circumstances, many of which (including legal and regulatory conditions) are beyond our control. There is no assurance that purchasers will realize value from the Protocol Tokens and it is possible that your entire investment will be lost. For this reason, you should carefully review these risk factors and should consult with attorney, financial and tax advisors prior to making any investment decision with respect to the Protocol Tokens.
The Protocol and the Protocol Tokens are new and relatively untested products. There is considerable uncertainty about their long-term viability, which could be affected by a variety of factors, including many market-based factors such as economic growth, inflation, and others. In addition, the success of the Protocol, cryptoasset networks and cryptoassets will depend on whether blockchain and other new technologies turn out to be useful and economically viable.
Risks Relating to Smart Contracts. The Protocol and the Protocol Tokens are generally comprised of and governed by a number of smart contracts. Smart contracts are computer code that can be created and run by the users of the network on which such smart contract or program is based. A smart contract can take information as an input, process that information through the pre-determined rules and conditions defined in the computer code, and execute certain actions, such as transactions, pursuant to such programming. The use of smart contracts creates substantial risk exposures. Smart contracts are self-executing once deployed, generally without reliance on a central party, and use experimental cryptography. Smart-contract risks include the following, which may affect adoption, continued use, or functioning of the Protocol and the value and utility of the Protocol Tokens:
Flawed or Imprecise Code. Smart contract code may be imprecise or flawed. In such cases, smart contracts comprising the Protocol and the Protocol Tokens could have specifications or conditions that are implemented or executed in ways that are not expected. You may be at risk of losing all or a substantial portion of your Protocol Tokens, and the Protocol may lose access to the Reserves, through an adverse event relating to such code. Smart contracts could contain vulnerabilities or bugs that could be exploited, potentially resulting in a complete or substantial loss of your staked digital assets. Malicious actors could exploit such vulnerabilities or bugs to cause the execution of erroneous or unexpected slashing conditions or theft of your digital assets or the digital assets held by the Protocol smart contracts as part of the Reserves.
Lack of Remediation. If imprecise or flawed code is discovered in a deployed smart contract, it may not be susceptible to identification ex ante and remediation may be difficult or ineffective. In some cases, the only practical remediation may include deploying a new smart contract or incorporating updating mechanisms that may be disruptive, risky, complex, costly, time consuming, and/or unable to reverse adverse scenarios, including complete or substantial loss of your Protocol Tokens or the digital assets held by the Protocol smart contracts as part of the Reserves.
Flaws in Programming Languages. The programming languages used to code smart contracts pose risks, including vulnerabilities arising from language complexity, potential bugs and flaws in language designs or compilers, limitations in functionality or performance impacting implementation, and a lack of maturity and sustained support for certain languages impacting the reliability and security of the developed contracts. Even widely used programming languages may have compiler bugs or other flaws that, if discovered and exploited, may result in substantial or total losses of digital assets, including your Protocol Tokens or the digital assets held by the Protocol smart contracts as part of the Reserves.
Lack of Control over Protocol and Upgrades. It is envisaged that the Protocol will ultimately be governed collectively by the community of its users, represented by holders of Protocol governance tokens (the “Protocol Governance Token”). This means that although the original developers of the Protocol have engaged in substantial research and development with respect to the Protocol and its security features, any future changes to the Protocol may need to be voluntarily adopted by holders of the Protocol Governance Token through the governance process. At this point, there will be no single party that is able to control the Protocol code, or to ensure that there is an adequate or timely response to emergencies or other identified risks. Protocol Governance Tokenholders may make decisions or take actions through the governance process (or fail to make decisions or take actions) in ways that adversely affect you and/or the Protocol. In addition, the Protocol may not run or function as intended and in such cases, you may have limited recourse. Any of these could result in substantial or total losses of the value of your Protocol Tokens or the digital assets held by the Protocol smart contracts as part of the Reserves.
Reliance on novel technologies. Various technology solutions are and will be incorporated into the Protocol. Some or all of these technology solutions are relatively new and/or untested. There is significant risk to building and implementing new technologies that may have never been used or that are being used in different ways. There is no guarantee that such technologies will operate as intended or as described in any marketing or other materials related to the Protocol, or will continue to function according to current plans.
Multiple Other Risks. It is possible that, due to any number of reasons, including but not limited to, lack of interest from users, inability to attract sustained third-party or community contributors to the Protocol, an unfavorable fluctuation in the value of digital and fiat assets and currencies, decrease in the utility of the Protocol, failure to generate commercial relationships, intellectual property ownership and other challenges, and macroeconomic and crypto-market-specific factors, the Protocol and the Protocol Tokens may no longer be viable to operate and it may be deprecated or cease to have any functionality, users, or viability.
Legal and Regulatory Risks
Legality of Digital Assets. It may be illegal, now or in the future, to own, hold, sell or use digital assets, including the Protocol Tokens, in one or more countries. Although currently digital assets are not regulated or are lightly regulated in most countries, one or more countries may take regulatory actions in the future that severely restricts the right to acquire, own, hold, sell or use digital assets or to exchange digital assets for fiat currency. Such an action may adversely affect the value or utility of the Protocol Tokens.
Unpredictability of potential enforcement actions. Unpredictability of potential enforcement actions may also present risks to the success of the Protocol if actions are brought with respect to the Protocol or the Protocol Tokens. The digital asset market is new, and may be subject to heightened oversight and scrutiny, including investigations or enforcement actions. There can be no assurance that governmental authorities will not examine the operations of the Protocol or the issuance or marketing of the Protocol Tokens, or enact regulations or pursue enforcement actions against the entities that have developed and that support the Protocol, including how the Protocol Tokens are supported, which may result in curtailment of, or inability to operate, the Protocol as intended. In addition, non-governmental parties may bring private legal actions which may result in curtailment of, or inability to operate, the Protocol as intended.
Risks of New & Evolving Laws and Regulations. There is significant risk surrounding the ongoing development of legal and regulatory frameworks governing blockchain technology all over the world, including in the United States, United Kingdom, European Union and other major jurisdictions, and as the blockchain, crypto, and web3 industry continues to grow, regulatory scrutiny is likely to increase across jurisdictions. The Protocol Tokens may be found to be subject to certain laws or regulatory regimes that could adversely impact you or the viability, utility, or value of the Protocol and the Protocol Tokens. Additionally, laws or interpretations may change and the Protocol or the Protocol Tokens may be subject to new or changed laws or regulations in the future. Any restrictive or prohibitive legislation or regulation on blockchains or digital assets could impair the adoption, viability, utility, or value of the Protocol or the Protocol Tokens and adversely affect market sentiment surrounding the Protocol Tokens.
Jurisdictional Restrictions. Due to legal restrictions, Protocol Tokens cannot be minted and will not be redeemable in certain jurisdictions. These jurisdictions are listed in the Terms of Service. Even if the Protocol otherwise has sufficient Reserves to redeem Protocol Tokens held by you, if you are resident in or accessing the Services from one of these jurisdictions, you will not be able to mint or redeem Protocol Tokens.
Risks Associated with the Tax Treatment of Digital Assets. The tax characterization of the Protocol Tokens is uncertain, and you must seek your own tax advice in all jurisdictions relevant to you in connection with your purchase and sale of Protocol Tokens. A purchase or sale (including any minting or redemption) of Protocol Tokens may result in adverse tax consequences to you, including withholding taxes, income taxes and tax reporting requirements. The uncertainty in the tax treatment of the Protocol Tokens and transactions in Protocol Tokens may expose holders to unforeseen future tax consequences.
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