dotUSD: A Native Stablecoin for Polkadot

This proposal signals the intent of the DAO to introduce dotUSD, Polkadot's native stablecoin, as the protocol's primary stable-value instrument.

Overview

This proposal, which has been drafted with contributions from builders, developers and
participants within the Polkadot ecosystem, proposes the launch of dotUSD, Polkadot’s native decentralized stablecoin, as the protocol’s primary stable-value instrument.

This governance proposal covers the following actions:

1. Create the new asset, dotUSD - owned by the protocol.
2. Recognize this asset as the Polkadot Stablecoin - dotUSD.
3. Create a liquidity pool on Polkadot Assethub for DOT x dotUSD. This allows individual users to swap back and forth between the two assets.
4. Use treasury funds for the initial liquidity in the DOT x dotUSD pool.
   $1.5M in USDT will be used to mint dotUSD and $1.5M in DOT will be allocated initially to the pool.
5. Set dotUSD as a sufficient asset. This allows users to hold only dotUSD on-chain, without requiring the user to also hold the DOT token.
6. Set the parameters for the PSM. The PSM is the mechanism that sets specifics regarding the token, e.g. the maximum cap for initial minting for phase 1.
7. Create a coinage instance for dotUSD.

Disclaimer – Polkadot Community Foundation (“PCF”)
For the avoidance of doubt, PCF is simply, in an administrative capacity and as a community
member and support vehicle, putting forward this proposal for DAO approval and its
implementation will not, and is not intended to, involve:

1. PCF deploying, controlling, distributing or operating dotUSD;
2. PCF issuing, controlling and/or taking custody over users’ digital assets or collateral
   including dotUSD, DOT, USDT;
3. PCF engaging in any liquidity provisioning;
4. Funds (or other user assets) flowing through PCF at any time; or
5. PCF engaging in, carrying on, or holding itself out as, carrying on any “virtual asset service” or other regulated activity for the purposes of the Cayman Islands Virtual Asset (Service Providers) Act (as amended), or any other Cayman Islands regulatory regime.

In fact, dotUSD is a decentralized, protocol-native stablecoin project. It would have no issuer
and would instead operate autonomously via on-chain logic.

The Case for a Polkadot-Native Stablecoin

The stablecoin has become, by any reasonable measure, the single most consequential financial primitive to emerge from the broader cryptocurrency experiment. It is the instrument through which ordinary economic activity, payments, savings, remuneration, commerce, becomes possible on-chain without requiring participants to accept the volatility inherent in the underlying cryptographic assets. For a protocol with ambitions as broad as Polkadot's, the absence of a native stablecoin is structural deficiency: it forces every user, every application and every treasury operation to depend upon instruments issued and governed by external parties, each carrying its own counterparty risk, its own governance constraints and its own capacity for unilateral intervention.

The centralized stablecoins which presently dominate the market, USDC, USDT and their various descendants, are, for all their utility, subject to precisely the kind of centralized control that the decentralized movement was conceived to transcend. They carry kill switches. They operate under the jurisdiction of individual nation-states. They can, and do freeze accounts and blacklist addresses without recourse to the holders affected. For a protocol to build its economic infrastructure atop such instruments is to accept a dependency which is, at best, philosophically incongruent and, at worst, an existential vulnerability.

Existing decentralized stablecoins on other networks, however well-designed, do not drive value for DOT. They do not lock Polkadot's native asset as collateral. They do not reinforce the economic flywheel upon which Polkadot's long-term value proposition depends. A stablecoin issued on Ethereum, bridged to Polkadot, remains fundamentally an Ethereum asset: its collateral sits elsewhere, its governance answers to another community and its success accrues value to another ecosystem.

dotUSD is the answer to all three of these shortcomings. It is a stablecoin issued natively within the Polkadot system, backed primarily by DOT, governed by Polkadot's own governance apparatus and accessible across the full breadth of Polkadot's products and services.

The Mechanism

dotUSD is an over-collateralized stablecoin pegged to the United States dollar. Its design draws heavily from the architecture pioneered by Liquity v2 (BOLD), adapted for Polkadot's particular circumstances.

The fundamental operation is straightforward: a user locks DOT, and against that collateral mints dotUSD at a value less than the collateral deposited. If, for example, a user deposits 300 DOT at a market price of $5 per DOT, they hold $1,500 in collateral and may mint up to $1,000 in dotUSD, representing a collateralization ratio of 150%. The system enforces a minimum collateralization ratio; should the value of the deposited DOT fall below this threshold, the vault is subject to liquidation, wherein the system seizes the collateral and sells it to recover the outstanding dotUSD debt.

A distinguishing feature of this design, inherited from Liquity v2, is that vault owners set their own interest rate on their borrowed dotUSD. This is not a protocol-determined parameter but a market-driven one: each borrower chooses the rate they are willing to pay, and that rate determines their position in the redemption queue. When dotUSD trades below its peg and arbitrageurs redeem dotUSD for DOT through the system, it is the vault with the lowest interest rate which is redeemed against first. Vault owners who wish to protect their collateral from redemption may do so by paying a higher rate, a premium for the privilege of remaining undisturbed. The result is an organically discovered interest rate curve, shaped entirely by the preferences and risk appetites of the participants themselves.

Peg Stability

The peg is intended to be maintained through two complementary arbitrage mechanisms. When dotUSD trades above one dollar, it may become an incentive for an actor to lock DOT, mint dotUSD at its nominal value and sell it on the open market at the prevailing premium. The additional supply is expected to put downward pressure on the price, and help bring it back toward the peg. When dotUSD trades below one dollar, an arbitrageur may purchase dotUSD cheaply on the market and redeem it through the system for one dollar's worth of DOT. The buying pressure this creates on dotUSD is expected to drive the price back up to the peg.

While the DOT redemption mechanism (proven in deployment through Liquity's LUSD and BOLD) provides the main peg floor, another method to improve peg stability will be to introduce into the system a stables buffer. This stables buffer is a capped supply of dotUSD backed by existing stablecoins which can be redeemed for 1 USD, with each asset having its own individual cap to ensure the buffer remains balanced. This introduces a method of peg mechanism which does not touch the DOT collateral or negatively affect DOT price. This is important in a network-native asset whose collateral is also tied to the network’s success, which can create a reflexive system.

Liquidation and Bad Debt

When a vault's collateralization ratio falls below the minimum threshold, the system liquidates the position against a stability pool: a reserve of dotUSD deposited by participants who, in exchange for fee, pre-commit their capital to absorb liquidations. The stability pool members receive DOT at a discount and their corresponding dotUSD is burned, cancelling the debt. So long as the stability pool contains funds, the risk of bad debt is reduced in comparison to other stablecoin implementations.

In the event that the stability pool is exhausted, the system redistributes the debt and collateral proportionally across all remaining vaults. Every vault inherits a small share of the obligation along with the corresponding collateral at the minimum collateralization ratio. No individual vault is rendered insolvent by this redistribution, although redistribution acts to bring the account towards the minimum collateralization ratio; the system degrades linearly.

The Reflexivity Consideration

It would be disingenuous to present dotUSD without acknowledging the particular challenge that arises from building a stablecoin collateralized by the native asset of the very network upon which it operates. In the Maker/Dai system, for instance, the stablecoin depends on Ethereum but Ethereum depends only marginally on Dai; the relationship is asymmetric and therefore manageable. In Polkadot's case, the relationship is bidirectional: dotUSD's success is tied to DOT's utility, and DOT's economic model increasingly depends upon dotUSD as the instrument through which specific treasury operations will be denominated. This reflexivity demands a more conservative design than might be required in other contexts, and it is precisely why the Liquity v2 architecture, with its stability pool to avoid liquidation shocks, redistribution backstop rather than minting and sale of another token was selected, and why the additional stables buffer was added such that within a range of volatility, the stablecoin’s peg can be maintained without needing to touch the DOT and directly affect its price.

Phased Rollout

The dotUSD system is designed for phased deployment in line with the research and development times for these mechanisms to be deployed on chain. A stablecoin backed by an asset which is volatile relative to the peg asset requires an oracle to get a reliable price.

Phase 1 - Stable Backed dotUSD
The first phase, which is already built and on chain, releases only the stables buffer mechanism: users may mint dotUSD one-to-one against USDT which can be redeemed for 1 USD, subject to a cap. This requires no oracle, no vaults and no liquidation logic and it allows dotUSD to enter circulation and begin to be integrated by applications and services while implementation of the oracle and full vault mechanism is finalized.

Phase 2 - DOT-collateralized Vault dotUSD
The second phase introduces the complete vault system with DOT collateral, oracle integration, the stability pool, liquidation mechanics and the redemption mechanism.

Connection to Polkadot's Economic Model

It is important to situate dotUSD within the broader trajectory of Polkadot's evolving economics. The network has recently undergone a series of reforms, each pointing toward the creation of sustainable value for DOT: a hard cap of 2.1 billion DOT and the introduction of the Dynamic Allocation Pool (DAP), through which all newly minted DOT flows into a central pool from which budgets for staking and treasury operations are allocated in dollar terms.

dotUSD is the instrument which makes dollar-denominated budgeting possible on-chain. Under the second phase of the DAP, validators and nominators are to be remunerated in stables; the Treasury is to receive a mix of stables and DOT. Without a native, decentralized, DOT-backed stablecoin, these operations would necessarily depend upon externally issued instruments with all the counterparty risk and governance dependency that entails. dotUSD closes this gap: it allows the network to denominate its obligations in dollars, disburse them in a native asset and retain full sovereignty over the process from issuance to settlement.

Liquidity provisioning

This referendum also proposes that the treasury create the DOT<>dotUSD pool on the Hub DEX and to seed it with treasury funds to a sufficient depth relative to the initially proposed maximum supply cap.

Summary

This proposal introduces dotUSD, Polkadot's native over-collateralized stablecoin, as the protocol's primary stable-value instrument.

Note
The pre-image for this ref relies on all system chains to be upgraded to 2.5 as per: https://polkadot.subsquare.io/referenda/1942