Onchain yield products continue to grow, but the underlying mechanisms are often misunderstood.
Unitas Yield Academy is an educational series that explains these mechanisms using clear examples and current data. In this issue, we explain the Peg Arbitrage Mechanism and how USDu maintains its $1 peg.
The most important property of a stablecoin is its peg.
A stablecoin is designed to maintain a certain value relative to a fiat currency, most commonly the U.S. dollar. Users hold stablecoins with the expectation that their portfolio value remains stable regardless of broader crypto market movements.
Stablecoins are used for payments, savings, using them in DeFi and taking profits from trading. Each of these use cases requires the asset to remain pegged to its target currency.
If a stablecoin does not maintain its peg, it fails to perform its intended function.
USDu maintains its $1 peg through a peg stabilization mechanism based on arbitrage incentives.
The mechanism is driven by temporary price deviations of USDu in secondary markets from its $1 redemption value within the protocol. Whitelisted users who have completed KYC and AML verification can mint and redeem USDu directly against USDC at a fixed 1:1 ratio.
Scenario 1: USDu trades above $1
If USDu trades above its $1 peg, a whitelisted user can mint USDu by depositing USDC at a 1:1 ratio. The minted USDu can then be sold on the market at a price above $1.
This creates a profit from the price difference and increases the circulating supply of USDu. The increase in supply applies downward pressure on the market price until it returns to $1.
Scenario 2: USDu trades below $1
If USDu trades below its $1 peg, a whitelisted user can buy USDu on the market at a price below $1. The purchased USDu can then be redeemed within the protocol for USDC at a 1:1 ratio.
This creates a profit from the price difference and reduces the circulating supply of USDu. The decrease in supply applies upward pressure on the market price until it returns to $1.
The peg is enforced through direct convertibility between USDu and USDC at a fixed rate.
This creates a price boundary where any deviation from $1 introduces a profit opportunity. Arbitrage participants execute these trades until the price converges back to $1.
Supply expands when price is above $1 and contracts when price is below $1. This dynamic adjustment keeps the market price aligned with the redemption value.
Price deviations can occur due to temporary market conditions. Users can verify whether a deviation reflects a real issue by checking protocol reserves.
Unitas provides real-time Proof of Reserves dashboards in partnership with Accountable and Primus. These dashboards show the value of assets backing USDu and the total USDu supply.
If the value of reserves exceeds the outstanding USDu supply, the protocol remains fully backed. In this case, a price deviation reflects temporary market conditions and arbitrage can be executed based on the price difference.
Users interested in participating in minting and redemption can request access in our Discord server by opening a support ticket.
Peg arbitrage is a core mechanism used to maintain the price of a stablecoin. It aligns market incentives with the ability to mint and redeem USDu at a fixed 1:1 ratio to keep it trading at $1.
Unitas continues to focus on transparency and user education. Future issues of Unitas Yield Academy will explain additional mechanisms used across onchain yield products as adoption increases across financial markets.