The stablecoin race has been going on quietly for a long time until recently. Almost every ecosystem has its own stablecoins; Ethereum, Solana, and even Hyperliquid. But how come there has never been a Bitcoin-backed stablecoin? This is where Hermitica’s USDh comes into the chat! Perhaps you just heard about USDh and you’re curious about its internal mechanics. Or you are considering whether you should invest in it… This short blog has everything you need to know; from how the yield works, to the risk, and even a review of the smart contract behind it. What is USDh? USDh is a yield-bearing dollar-pegged stablecoin backed by Bitcoin, instead of fiat or an algorithm. At the moment, it currently has a Total Value Locked (TVL) of $6.6 million. Created by the Hermitica team, there are 2 main theses behind why USDh was created. The first is how no stablecoin is backed by Bitcoin. Of course, some popular stablecoins like USDT are backed by dilution of Bitcoin, gold, and bond. But none is fully backed by Bitcoin. Meanwhile, Bitcoin has proven to be the most sound monetary system over the years with incremental adoption and economic relevance. Also, Bitcoin is an onchain asset that is not controlled by any nation-state, which makes it a perfect backer for a solid stablecoin. Moving on, the second reason rests on how holding stablecoins doesn’t profit the holders. For instance, anyone who keeps $500k worth of USDT will still meet that same amount in the next 6 years. For context, there are now avenues where you can stake USDT for rewards. However, none offers the percentage of yields that USDh currently places on the table. USDh was created to effect a change where holders can get rewards, or yields as we prefer to call them. There is a promised 25% APY on USDh, and we will explain how such a percentage of yield is accumulated later on in this blog. Hermitica has been running the token for over a year now, and its APY mechanics seems to be working. Of course, this is not to mean an investor should 100% trust the system. Bear this in mind, because a protocol has delivered on a promise in the past is not a guarantee it will do in the future. That said, the APY scheme seems to be among the highest in the market. How is it created and pegged? The system of minting USDh is pretty straightforward: any doxxed entity can approach Hermitica to mint the token, so far they are willing to deposit Bitcoin in return. The main concern here is how Hermitica emphasizes KYC/AML. While these preconditions can be understandable from a regulatory perspective, they raise concerns on the cyperphunk philosophy, which is based on anonymity. At the moment, these entities are largely exchanges and big protocols that want to provide USDh as liquidity within their products. That said, they can always redeem their USDh back for their Bitcoin, if they so will. Moving on to the peg, what are the systems in place to ensure one USDh is always equal to $1 USD? This is where the concept of Arbitrage comes in. Hermitica has some approved addresses that can exploit the difference in the price for their benefit. If USDh drastically drops to $0.7, they can buy up lots of the token and sell it to the protocol at the $1 tag to stabilize the market. Again, if it’s the case that it’s higher than $1, they can mint more USDh at $1 to draw down the price to its peg. Along this line, there is also an Hermitica Reserve Fund kept specifically to stabilize the market and manage any onchain stress. So, where does the yield come from? In DeFi, we say if you don’t know where the yield is from, then you are the yield. Yes, USDh promises an impressive APY, but you must also investigate how that yield is made. Or else, you are one rug away – remember UST! The yield mainly comes trading Bitcoin futures. If you are also familiar with futures trading, then you must be well aware of funding rates; simply put, it’s the fraction long traders pay to those who short. Now, since Bitcoin is always going up, there will always be longed trades. As a result, long traders will always pay funding rates. It is from these funding rates that USDh extracts its yield, demonstrated in sUSDh, to pay holders. See it this way. Long Bitcoin trades → Funding Rates → Yield What are the risks in buying USDh? Just before you go ahead to add some USDh into your portfolio, you should be aware of the things that can go wrong and can potentially make you lose your bags. It’s not the case that these risks will happen, but they sure have a chance of occurring. As a result, you should prepare your mind; diversify your holding, and be on the edge. Platform Risk There are many platforms involved in how liquidity is stored and moved for USDh. The first one is the treasury. Hermitica seems to be quite transparent with how they are storing the funds at Copper and Cefu. If anything goes wrong there, there will be instability in the market. But on a good note, there is no history of breach with these platforms. The second one is the risk around exchanges. USDh revolves heavily around future trades, which heavily happen on exchanges. There can be market instability if these exchanges are hacked. Excessive Bitcoin Shorting The entire premise of generating yields is predicated upon the fact that traders will always want long leverage in Bitcoin. The aforementioned premise is further based on the fact that Bitcoin will always go up, and there will always be demand for it. However, what if Bitcoin has a sudden marginal fall, and the desire to long leverage it drastically reduces? In that case, there will be no much yield, and the promise of