Fundamental Insights
In CeFi, derivatives usually refer to financial products such as options and futures contracts, while in DeFi, people have proposed a new concept of synthetic assets in addition to the conventional decentralized options and futures products. The principle of synthetic assets can be summarized by a simple formula: collateral + synthetic algorithm = synthetic assets.
Synthetic assets provide a new way of thinking and a new form of derivatives. The Tokenization feature makes futures and options contracts themselves become an “asset” with tradable and collateralizable characteristics, which can be used to build more diverse DeFi products. In addition to Tokenization of futures and options contracts, “assets” based on the collateral model are the main form of synthetic asset market at present, with representative projects such as MakerDAO, Sythetix and Mirror.
In the blockchain world, synthetic assets meet the financial needs of users such as hedging, arbitrage and speculation. Compared with real assets, synthetic assets have the following advantages.
1. lower entry barriers, e.g., users do not need to open securities accounts and can enjoy the benefits of their appreciation by holding synthetic assets such as gold and U.S. stocks.
2. global liquidity, as crypto assets are circulated worldwide, so their corresponding synthetic assets can enjoy global liquidity, not a particular person or company.
3. Enabling slippage-free trading, with the nature of synthetic assets, slippage-free DEX is possible in certain synthetic asset protocols, thus greatly enhancing the user experience.
Synthetix has become an important development direction for DeFi, and there are several projects exploring this direction, a few of which are briefly summarized below.
Synthetix
Synthetix is an ethereum-based decentralized synthetic asset issuance protocol. These synthetic assets are secured by Synthetix Network Passes (SNX), which can be issued by locking the SNX in a smart contract (Synths). This collateral pooling model allows users to perform conversions between Synths directly using smart contracts without the need for counterparties. This mechanism solves the liquidity and slippage problems experienced by DEX. Synthetix currently supports synthetic fiat currencies, cryptocurrencies (long and short) and commodities. The system encourages users to hold locked SNX by paying a pro-rata share of the transaction fees generated on Synthetix.Exchange to holders who participate in collateralizing (staking) the SNX issuance of synthetic assets based on their contributions. Trading on Synthetix.Exchange does not require SNX holdings.
Synthetix uses a shared debt pool model where collateralists assume the risk of all debt in the system. They have the option to hedge this risk by hedging outside the system. By assuming this risk, all collateralists enable the generation of trades on Synthetix and thus receive a share of the trade rewards generated by the system. This can be understood by looking at the following Delphi Digital example.
Step 1: Medio and Yan both make an initial investment of $50,000, and the total debt of the network adds up to $100,000. Medio and Yan are responsible for 50% of this amount each. Step 2: Medio uses his $50,000 to buy sBTC, while Yan continues to hold sUSD. Step 3: The price of BTC rises by 50%, which means that Medio’s position becomes worth $75,000, with $25,000 in profits bringing the network’s total debt to $125,000. Step 4: Medio and Yan are still each responsible for 50% of the network’s total debt, or $62,500 each. When the value of Medio’s sBTC is subtracted from his debt, a profit of $12,500 is made; even though Yan’s position is worth $50,000, his debt is increased by $12,500, which is a loss of $12,500.
UMA
UMA is a synthetic asset issuance protocol through which any of the synthetic assets can be issued. There are currently 11 projects on it, divided into three main categories: Digitally Native Index, Yield Dollar, and Synthetic Asset Exchange. creating tokens with special features DigitallyNative Index is the most interesting category, Domination Finance UMA has created a series of products for specific needs that make good use of the characteristics of synthetic products.
Standard Product Protocol UMA uses a standard product contract, the ExpiringMultiParty (EMP) contract, to allow developers to quickly bring synthetic asset tokens online that can expire. The UMA protocol also has tokens, UMA Tokens, which can be used to resolve its dispute resolution system, DVM (Data VerificationMechanism), and to govern the protocol as a whole. The main uses for holding UMA Tokens are 1) to receive rewards for voting on price demand using DVM and 2) to receive governance rewards for upgrades to the protocol parameters. UMA recently launched its newest contract, LSP (The Long Short Pair), which builds a new contract template called the Long Short Pair (LSP) that allows for the creation of arbitrarily complex derivatives with homogenized long and short positions, and does not require active position management by the user.
Unlike UMA’s EMP contracts, casters do not have to worry about liquidation due to price fluctuations in composites or pledges. Unlike other solutions in this space, LSP does not integrate a complex or costly real-time on-chain price push mechanism, but rather puts prices on the chain once and for all in a trust-free and manipulation-resistant manner.
XCarnival
XCarnival is a new generation of synthetic asset protocol, which solves the pain points of high threshold, low liquidity and difficult operation of synthetic assets through four components: “XBroker”, “Megabox”, “XArena” and “XAdapter”, and creates a user-driven and easy-to-operate synthetic asset protocol.
“XBroker” provides a market maker function, through which market makers coordinate with pledgers and lenders to cover less liquid tokens and even some NFTs that cannot be priced directly.
“Megabox” will guarantee the introduction of non-mainstream tokens and even LPs into the collateral pool, freeing up liquidity.
“XArena” offers a rich set of templates with customizable parameters that will allow users to provide bidding and gamification of product design.
“XAdapter provides the underlying support for XArena, including the prophecy machine, auction clearing system, and offline data tracking services.
XCarnival, the first time-limited auction liquidation mechanism, is dedicated to building the leasing, pawning and lending business of non-standard assets. Its “pawn” idea cleverly solves the problem of capital utilization of NFT and other illiquid assets. By providing users with a collateralized borrowing platform through the idea of pawning, it improves the utilization rate of users’ assets while the platform does not need to worry about the problem of bad debts, thus greatly reducing the risk of platform operation.
XCarnival will support more than 20 different types of collateral assets, lowering the threshold for synthetic assets. At the same time, the choice will be first deployed on BSC and L2 platforms with lower user costs, further lowering the user threshold, and XCarnival may migrate to more EVM-compatible platforms in the future.
FL Summary: Synthetic assets are the alchemy of the financial world, and in this area of DeFi, we are pleased to see a variety of synthetic asset innovations emerging, including some DeFi Native assets such as stablecoins, crypto tokens, and derivative contracts, as well as some real-world synthetic assets such as US stocks, gold, and stock indices. Of course, while recognizing the potential of synthetic assets, one should also be aware of the risks involved. Since most synthetic assets are based on smart contracts and Oracle implementations, users should also be aware of the risks associated with smart contracts and Oracle during actual use.
In conclusion, synthetic assets are becoming a key part of the DeFi ecosystem, where everything can be synthetic and innovation never sleeps. But it’s still in its infancy, and we have reason to expect more innovation from more talented developers to bring new synthetic asset projects to market.
