What is a Crypto Synthetic Asset?
A crypto synthetic asset, also known as a crypto synth or synthetic asset, is a form of financial instrument designed to mirror the value and performance of real-world financial assets.
Crypto synthetic assets function like their traditional derivatives counterpart, which allows investors to speculate on the price of an asset without directly owning it. This speculation is often carried out using a futures contract.
The key distinction lies in the fact that crypto synthetic assets employ sophisticated mathematical formulas and equations powered by smart contracts to facilitate this process.
Smart contracts are a complex series of preset commands executed by a platform once certain conditions are met. They are also embedded in blockchain technology due to its immutability and transparency.
To monitor the performance of real-world assets, a dedicated token is crafted for this specific purpose.
Crypto synthetic assets are prevalently used in the decentralized finance (DeFi) ecosystem – a subset of the crypto sector.
On this platform, crypto synthetic assets can track asset value and performance, leverage collateral to secure value, and create derivative products seamlessly without relying on centralized authorities like their traditional counterparts.
How Do Crypto Synthetic Assets Work?
Crypto synthetic assets track real-world assets (RWAs) in real-time. This is accomplished through a process known as minting, where one asset is exchanged for another.
The minting process allows synthetic assets to maintain a 1:1 basis with the underlying asset, deriving its original value. Once these new tokens are minted, they can be seamlessly utilized on subsequent platforms.
These assets are deposited into a smart contract (or custodians in centralized operations like Circle), which then mints or generates new tokens equivalent in value to the original asset.
Hence, if a user deposits 1 BTC into a smart contract, a corresponding amount of 1 WBTC (synthesized version) with all the functionalities of the original crypto asset is created and deposited into their wallet address.
Types of Crypto Synthetic Assets
Crypto synthetic assets are categorized into two primary types – centralized and decentralized assets.
Centralized options are typically governed by a single entity, group, or individual who holds authority over the minting process and determines the quantity of tokens generated.
In contrast, decentralized versions operate on a permissionless basis, facilitated by a community of individuals within a broad ecosystem.
Examples of other forms are explored below.
This is the most popular form of centralized crypto synths. These cryptocurrency tokens, regarded as synthetic stablecoins, are usually designed to emulate the stability of fiat currencies such as the dollar, euro, or pound.
Maintaining a 1:1 peg to the fiat currency they replicate, these assets serve as valuable instruments for the seamless exchange of goods and services, as well as for storing value within the crypto ecosystem.
A viable option is the sUSD stablecoin, offered by the Synthetix platform. It offers users all the capabilities of the US dollar as well as the stability inherent in the greenback.
Leveraged and Inverse Tokens
This is another form of centralized crypto synths. These tokens are designed to either enhance or counteract the price fluctuations of an underlying asset.
Given this, when the value of an asset plunges, holders of inverse tokens benefit from the price decline. On the other hand, leveraged tokens usually enhance the profits or losses of those who hold them.
An example is the BTC3L, which is Binance’s BTC Leveraged Tokens. They essentially allow investors to earn three times higher than the value of the original Bitcoin asset.
Hence, when Bitcoin climbs 1%, the BTC3L surges 3% higher, making it a profitable way of trading the decentralized asset.
Yield-Bearing Synthetic Assets
Yield-bearing assets are a decentralized format of synthetic assets often found in the DeFi ecosystem. These artificial assets allow users to earn returns by staking or lending their tokens to others for trading. In exchange, they receive a variable annual percentage yield, making it a viable passive income-generating pool.
cDAI falls under this format of synthetic assets. The digital asset is offered on the Compound protocol ecosystem. cDAI is a synthetic asset mimicking the value of the decentralized stablecoin offered by the MakerDAO protocol. When users lend their cDAI assets, they earn a variable interest on them on an annual basis.
Tokenized Commodities and Equities
Tokenized commodities and equities extend beyond the realm of cryptocurrencies. Commodities and stocks are also being synthesized.
Investors can own fractional units of these decentralized synthetic assets directly redeemable for their real-world counterparts.
A typical example is the sOIL commodity on the Synthetix platform. This allows users to become commodity traders without owning a barrel of crude oil in their portfolio.
Crypto Synthetic Asset Use Cases
As blockchain technology continues to evolve, the adoption of synthetic assets has become increasingly prevalent. Below, we outline key applications of this emerging technology amongst investors.
- Investment Opportunities
One of the primary applications of synthetic assets is in trading and investment. Notably, these assets empower users to unlock leveraged trading opportunities across various asset classes.
This includes seamless exposure to commodities, stocks, fiat currencies, and cryptocurrencies, allowing users to potentially earn higher returns (or incur substantial losses) than traditional trading methods.
This expansive asset type syndrome makes it possible for investors to diversify their portfolios without necessitating significant capital commitments.
- Liquidity Provision and Yield-Farming
Liquidity is king in finance, and synthetic assets are viable options to provide much-needed capital. Users who contribute synthetic assets to liquidity pools on DeFi ecosystems often receive rewards in the form of more synthetic tokens from other traders who utilize those funds.
They can make extra tokens by directly staking or locking their funds into a blockchain network.
- Hedging Risks
Hedging risks are also a major concept in the blockchain landscape, and synthetic assets provide the needed coverage. Investors can use inverse synthetic assets to hedge or protect their funds from plummeting or declines.
For example, Synthetix’s dSNX is used to hedge an investor’s debt, making it possible for them to protect the value of their asset from volatility.
Why are Crypto Synthetic Assets Important?
The common inquiry about crypto synthetic assets centers on their importance.
Below, we outline the key advantages.
This means users can engage in trading synthesized versions of bonds, stocks, commodities, and major currencies without directly dealing with the underlying assets. This flexibility empowers investors to diversify their portfolios, customizing their investments to align with specific financial objectives. This makes them permissionless and sanction-resistant, enabling individuals from any region to access these artificial investment tools directly. This allows investors to purchase fractional units of these assets, thereby saving on applicable investment costs and platform fees simultaneously.
Crypto synthetic assets break the mold of being confined to a single financial instrument. They provide users with the opportunity to access a broader range of assets.
A growing number of synthetic assets are offered on decentralized blockchain protocols, making it possible to sidestep intermediary platforms.
Synthetic assets are often crafted from futures contracts of an underlying asset instead of making physical purchases.
Synthetic asset platforms are easy to get started on. They are often based on new-generation technologies that don’t require users to undergo lengthy sign-up processes.
This means users can engage in trading synthesized versions of bonds, stocks, commodities, and major currencies without directly dealing with the underlying assets.
This flexibility empowers investors to diversify their portfolios, customizing their investments to align with specific financial objectives.
This makes them permissionless and sanction-resistant, enabling individuals from any region to access these artificial investment tools directly.
This allows investors to purchase fractional units of these assets, thereby saving on applicable investment costs and platform fees simultaneously.
Crypto synthetic assets are the next-generation financial derivatives that have captured global attention. With their ease of admittance and expansive asset range, synthetic assets present enticing opportunities for investors.
However, they are still in their nascent state and are largely unregulated in most regions. Users are advised to do due diligence before interacting with these financial tools.