The hippocampus plays a critical role in the rapid learning of new episodic memories. Many computational models propose that the hippocampus is an autoassociator that relies on Hebbian learning (i.e., “cells that fire together, wire together”). However, Hebbian learning is computationally suboptimal as it modifies weights unnecessarily beyond what is actually needed to achieve effective retrieval, causing more interference and resulting in a lower learning capacity. Our previous computational models have utilized a powerful, biologically plausible form of error-driven learning in hippocampal CA1 and entorhinal cortex (EC) (functioning as a sparse autoencoder) by contrasting local activity states at different phases in the theta cycle. Based on specific neural data and a recent abstract computational model, we propose a new model called Theremin (Total Hippocampal ERror MINimization) that extends error-driven learning to area CA3 — the mnemonic heart of the hippocampal system. In the model, CA3 responds to the EC monosynaptic input prior to the EC disynaptic input through dentate gyrus (DG), giving rise to a temporal difference between these two activation states, which drives error-driven learning in the EC→CA3 and CA3↔CA3 projections. In effect, DG serves as a teacher to CA3, correcting its patterns into more pattern-separated ones, thereby reducing interference. Results showed that Theremin, compared with our original model, has significantly increased capacity and learning speed. The model makes several novel predictions that can be tested in future studies.