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What are synthetic assets in cryptocurrencies?
Synthetic assets in cryptocurrencies allow investors to invest in real-world assets (RWA) in tokenized form.
Posted May 17, 2024 at 6:43am EST.
The advent of decentralized finance (DeFi) has given rise to many new financial concepts. Synthetic crypto assets, also known as Synth, are one of them.
Read on to learn about synthetic assets in cryptocurrencies, including what they are, how they work, and what types of synthetic assets you can invest in.
What are synthetic assets?
Synthetic assets are tokenized, blockchain-based financial products that mirror the values and characteristics of real-world assets (RWA).
Holding these assets does not necessarily mean owning the underlying asset. While these have been a staple of TradFi, they are relatively new to the decentralized financial ecosystem.
Synthetic crypto assets can have stocks, commodities, real estate, indices and other types of assets as underlying assets.
How do synthetic assets work?
The main idea behind synthetic assets is a contract that tracks the value of a specific asset. Therefore, the contract would pay the investor based on the latter’s performance. Let’s consider a simple analogy to explain them.
Imagine a cryptocurrency investor who wants to invest in a commodity, such as oil, but does not want to hold the physical product. To achieve this, they would have to create a Synth to monitor the price of a barrel of oil.
Synth is a digital token that tracks oil price movements. If the value of oil were to rise, the investor would be at an advantage.
How do you create a synthetic crypto asset?
To create a Synth it is necessary to find a platform that supports its development and trade. Common examples include Synthetic, Cream Finance, Marker DAO, and Mirror. While platforms may differ in requirements and processes, the general steps for building synthesizers remain the same.
- Select the asset below for which you want to create a synthetic version. These could be stocks, fiat currencies, commodities or even other cryptocurrencies.
- Deposit the collateral, typically the native token of the platform or protocol. The guarantee ensures that there are sufficient reserves to meet the contract payments.
- Mint synthetic assets use a smart contract which encodes the resource logic and more. The smart contract issues a token that represents the synthetic assets, such as sAAPL for Apple’s synthetic stocks.
- Store the synthetic crypto asset or trade it on a decentralized cryptocurrency exchange of your choice.
Types of synthetic crypto assets
Synthetic crypto assets are as diverse as the needs and purposes of individual investors. Here are some common ones.
Synthetic goods
These synthesizers reflect the values of commodities such as gold, oil and silver. One example is sXAU, a synthetic gold token from the Synthetix stable.
Synthetic currencies
It is also possible to create synthesizers that mimic fiat currencies such as the US dollar, euro, and yen, among others. One example is sUSD, a synthetic USD token from Synthetix.
Synthetic actions
These tokens track different stocks and stock indices around the world. For example, sTSLA is a synthetic token that simulates Tesla shares.
Leveraged and reverse tokens
Leveraged and reverse tokens work by boosting or balancing changes in the prices of the underlying asset. The former increase profits and losses, while the latter profit when the asset makes money. An example is Binance Leveraged Token BTC3L.
Fruitful synthetic assets
These tokens earn returns for investors by accumulating or lending their holdings. An appropriate example is Compound Protocol’s cDAI token.
Advantages and disadvantages of synthetic crypto assets
Like any investment, cryptosynthetic assets have advantages and disadvantages. Here are some of each:
Professionals
- Access to diversified markets: Synthesizers allow investors to access a wide selection of assets and markets that would not normally be available.
- Increased liquidity: Tokenizing assets and trading them on DEXs improves their liquidity, which increases the timely transfer of assets if necessary.
- Fractional Ownership: Tokenization of synthetic crypto assets supports the ownership of fractions of assets so that investors can participate in investments that would normally exclude them.
- Stimulating innovation: Synthesizers create new opportunities and possibilities in the realm of digital assets. Users can experiment with new ideas such as synthetic NFTs, DAOs, and memes.
Against
- Complexity: Investing in synthesizers requires understanding complex processes, including smart contracts, derivatives, oraclesand collateralization. This can prevent those who are not as knowledgeable in those areas from pursuing them.
- Regulatory uncertainty: Regulation around synthetic crypto assets is poor, creating uncertainty and compliance challenges, a barrier for some investors.
- Counterparty risks: Synthetic assets depend on the robustness of smart contracts and the platforms that support them, which may be susceptible to hacking and other vulnerabilities.
- Dependence on decentralized platforms: The performance and stability of synthesizers depend on the DEXs they operate on. There is a danger of experiencing congestion, high gas rates and other network limitations.
Final words
Synthetic crypto assets offer investors a flexible means to access a wide range of assets within the crypto space. By bridging the gap between traditional financial instruments and the decentralized world of cryptocurrencies, synthetic cryptocurrencies open up new opportunities for market participants.
However, it remains crucial for investors to conduct thorough research, understand the associated risks and opt for reliable platforms to mitigate potential drawbacks.