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Understanding Synthetic Assets and What It Means in DeFi

Trading

5 min read

With the rise of decentralized finance, new services as well as new forms of assets have emerged. Among the latter, we find synthetic assets which may seem complex at first glance. Synthetic assets were created to meet specific needs for a category of users and traders.

In traditional finance, there are so-called derivatives that represent assets such as commodities, precious metals, stocks, quotes or bonds. As for synthetic assets, it is the same principle, except that with crypto-assets, we use the process of "tokenization". This consists of creating a digital version of a real-world asset. This can be a stock, real estate, a raw material, etc.

What are synthetic assets?

Synthetic assets are essentially tokenized derivatives. This means that they are then represented by tokens and are hosted on a blockchain, allowing them to be transferred and exchanged digitally.

In traditional finance, derivatives allow traders to speculate on the rise or fall of an asset without having to actually own it. This is the same advantage that there is with synthetic crypto assets.

This allows investors to access a new asset class in a simple way. In this, synthetic digital assets open up new opportunities. They are also democratizing the financial sector and making it more accessible to everyone around the world.

What are the advantages of synthetic assets?

Decentralized finance, unlike traditional finance, does not require centralized intermediaries such as banks or brokers. By using blockchain, decentralized finance creates a transparent, open, and universally accessible system. Based on smart contracts , human error and manual modifications are prohibited. A smart contract can, for example, be programmed to release salary funds on a specific day. These contracts activate automatically, enabling transactions to be carried out without external intervention.

Through their functioning, synthetic assets provide security (of the network on which they are hosted) and above all the traceability of operations. All transactions are recorded on a ledger and anyone can access them. This prevents the risk of fraud, for example.

Why are synthetic assets important in DeFi?

Synthetic assets provide the opportunity to expand financial instruments and investment strategies in decentralized finance. In addition, in DeFi, there is better risk management and transparency which is lacking in traditional finance. In reality, there are several advantages that synthetic assets bring to DeFi.

Let's see the most important ones here:

➡️ A realistic representation

Synthetic assets are created through the process of “minting”. This means that a synthetic asset represents the asset’s real-world value. The synthetic asset is then backed by a real-world asset. As many tokens as possible can be created as long as an equivalent value of the collateral supports the total value of the created tokens. This way, the value of the assets can be transferred directly and in a secure and transparent manner. This also streamlines transactions and makes them more efficient for investors.

➡️ Decentralized and Anonymous

Synthetic asset exchanges are non-custodial. This means that assets are not held in the name of users. Decentralized exchanges do not practice KYC and exchanges are carried out in principle, anonymously.

➡️ Flexibility and Risk Management

This is perhaps the greatest benefit for investors, namely being able to gain exposure to a wide range of assets such as stocks and bonds without having to directly purchase the underlying asset. Investors can then adapt their investments and diversify the products in their portfolios. They can then use approaches that will hedge market risks or limit market fluctuations, for example.

➡️ Reduced transaction costs and commission fees

Synthetic assets are used in transactions at a much lower cost than traditional assets. Moreover, synthetic assets can benefit from greater liquidity on exchanges, which saves money for the platforms. Similarly, investors who have a low budget can also participate and invest in synthetic assets. This is also what explains why there is more liquidity.

What are the main protocols using synthetic assets?

There are several platforms that provide access to synthetic assets. These are websites where it is possible to easily buy and sell assets. One of the first platforms of this type was Synthetix , which is one of the best-known platforms today.

Synthetix

synthetic protocol — Source: https://synthetix.io

This is a decentralized finance protocol that allows trading of synthetic assets developed primarily on the Ethereum blockchain . Synthetix's native token is SNX, which can be used as collateral against synthetic assets. It is also possible to stake SNX tokens to generate returns and secure the network.

Synthetix has developed a broad ecosystem with various useful protocols. For example, traders can trade synthetic assets on the decentralized exchange (DEX) Kwenta.

Read : The 3 best DEXs for decentralized trading

Syntherium

Synthereum is the first protocol developed by Jarvis Network. It's a protocol that allows the creation of synthetic assets based on fiat currencies. This makes it possible to have forms of euro-based stablecoins , such as jFIAT.

MakerDAO

MakerDao is a decentralized platform that allows investors to gain exposure to traditional assets while using cryptocurrencies as collateral. For example, it is possible to deposit ETH as collateral to create a synthetic dollar called DAI.

Learn more: How does MakerDAO and DAI work?

Conclusion on synthetic assets

As we have seen, ultimately, synthetic assets are a formal evolution of traditional derivatives. They provide more flexibility and more transparency than their counterparts in traditional finance. Likewise, investors can use them for controlled and personalized exposure according to the assets of their choice.

As more people enter decentralized finance, it is highly likely that synthetic assets will become ever more popular among investors.

We will dedicate a series of articles to you which will detail certain protocols in order to make the best use of synthetic assets.

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Note : No financial advice is given in this article or any other article on ZoneBitcoin. This information is entirely your own judgment. Be responsible for your investments and only invest an amount you are prepared to lose.

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