What are Crypto Synthetic Assets, and How they are shaping the future of finance? we will talk about this in this comprehensive guide.
The world of DeFi is impacting lives in ways we could never imagine. It is growing at an unbelievable pace, with new protocols expanding the ecosystem. Until now, we have seen projects produce decentralized applications with similar functionalities as traditional financial products. We see traders swap tokens, lend a fraction of their share in the money market, and participate in exchanges using margin and leverage.
But that is not where DeFi ends. We can go much further with decentralized blockchain networks and build applications that turn everything we know about financial markets upside down. The first and most popular example is Crypto Synthetic Assets.
By simulating the growth of another asset, synthetic crypto assets provide opportunities for everyone with little to no barriers to entry. Synthetic assets have a unique digital representation of a derivative with a little DeFi twist, and it derives value from the underlying stocks, currencies, and commodities. In this article, we will discuss different aspects of Synthetic assets and explore the top five protocols leading the way in shaping the future of crypto finance
What are Synthetic Assets?
Synthetic assets closely resemble derivatives of any traditional market. As a derivative derives value from its underlying asset/index, it is tied to that particular asset in the form of a contract. In the same way, synthetic assets represent some other asset, but it uses Defi blockchain networks to establish that relationship in the form of tokens.
By mirroring the role of traditional derivatives, synthetic assets are now enabling traders and investors to buy digital assets that represent and track popular stocks or commodities. For example- the recent Gamestop incident can be used to derive new synthetic assets and track their price using an off-chain verification system via oracles.
Why Defi and Derivatives a mutually beneficial pair?
If there was no open finance movement, we would not have fractional ownership of an asset. You cannot buy a piece of land and earn good returns. You cannot increase your yield by investing in real-world assets like stocks or precious metals.
With DeFi in play, we are now witnessing the broadening of horizons in the crypto finance ecosystem. Defi and Derivatives form a mutually beneficial pair because they make difficult-to-access commodities available to both retail and institutional investors in the same way.
By leveraging smart contracts, we can automate many backend operations and make the exchange platform immutable. Without Defi, trading derivatives from any part of the world would be challenging, so having that ability to incorporate borderless transactions and enabling everyone in the world makes it the best relationship in crypto finance.
Advantages of Synthetic of Assets
We all know some basic advantages of synthetics assets like permissionless creation or no central party risk. But there are so many untapped use-cases associated with synthetic assets. Here are four major advantages of synthetic assets:
Tokenization makes any asset tradable
Synthetic assets unlock new markets in the world of finance and create new sources of value. It is done by tokenizing assets existing in the traditional markets. You can create a permissionless token out of anything and trade without a central figure. For example, if you want to create a token and track Co2 released by the industry, you can use new synthetic asset tokenization.
Synthetic assets can make funding a lot easier
In the initial stages, it is hard to find liquidity providers for new assets, but when it comes to obtaining funds via loan- synthetics are the best solution. A party can raise funds by using their existing assets and giving counterparties good interest rates. This is a lot like secured loans, as the party requiring funds agrees to buy securities and buy them back later.
Synthetic assets can inject liquidity much faster
The first thing any investor does before buying a considerable amount of stocks or contracts has checked the liquidity of that particular market. With synthetic assets, investors do not have to worry about liquidity. Their costs will be reduced as well. The derivative contract used for injecting liquidity at a much faster rate is a credit default swap. With buyers hedging their exposure and buyers going long on the underlying asset, the liquidity drastically improves in a short period of time.
Zero Barriers to Entry
In an open market like crypto, it doesn’t matter from which location and country to participate. It is virtually accessible to everyone that wishes to buy synthetic assets. With fewer barriers to entry in this space, it allows investors from all walks of life to create cash flows by having fractional or complete ownership of their desired financial instruments.
Few Examples of Synthetic Assets
It is not necessary that synthetic assets only replicate stocks or other derivatives, it can also be any crypto-native assets. We can create contracts on many factors and track its progress to make profits from each token. Here are few examples that can give you a better idea about synthetic assets:
Hash-Power & Mining Capacity Swaps
Managing mining machines and operating them every day may not be your cup of tea, so you should check out synthetic hash rate-based assets. Retail investors can benefit from investing in such assets, as it is impossible to work with equipment at a large scale. Synthetic assets can even issue machine tokens to virtually represent a part of the mining machine. These are beneficial for both traders and miners, as they can balance their portfolios in a better way and hedge against any risks in future.
Stocks & Indexes
As we mentioned earlier, physical assets can be tokenized using synthetic assets, including stocks, indexes, and even debt instruments like bonds. If we take the S & P 500 index and make a token out of it, traders buying would profit with a higher return as the index goes up. We have seen Mirror Protocol declare S&P 500 as a synthetic asset on their platform just a couple of months back, so it can be done with any stock and financial instrument.
To help you understand how permissionless synthetic assets can be, we have chosen poop exchange as an example. A synthetic asset designed to track the frequency of poop sightings in San Francisco was created in 2019 by a few developers. It sounds funny and is hilarious, but it also showcases the potential of synthetic assets and their ability to create new markets.
Staking Yield Swaps
This is similar to a hash-power contract, as it helps miners and other participants in the proof-of-stake network to hedge their market exposure. In the case of Staking yield swaps, a validator would trade a fraction of their yield for cash. This is a win-win for both buyers and sellers, as the buyer gets required staking income without having any infrastructure, and the seller would receive a fixed amount.
Top 5 Synthetic Asset Protocols in 2021
DEUS Finance is one of the finest protocols we have in this segment of the crypto market. It delivers an immersive experience to its users by providing global access to all marketplaces. From currencies like the US dollar or The Japanese Yes to precious metals like gold, DEUS fiance got you covered.
DEUS Finance has become one such platform that every crypto user should check out by eliminating intermediaries and adding a touch of decentralisation. On their platform, synthetic assets are called “dAssets” and are pegged at a 1:1 ratio. Recently, the company launched the protocol on the XDAI blockchain and BSC is also being considered.
If we want to accelerate crypto adoption in all aspects, we need to see more retail participating in the derivatives market with fewer risks attached. One of the best ways to do that is to buy synthetic assets representing the underlying value from an open-source protocol like UMA. Its open-source nature helps build trust and makes everything more transparent.
With the help of UMA, any two parties can create custom financial contracts and launch ERC-20 tokens on Ethereum’s blockchain. Having Ethereum’s smart contracts and incentive options, these contracts are secured in every way possible. By eliminating legal frameworks/recourse, UMA delivers a trustless, permissionless mechanism for all its users.
DAFI is a protocol incubated by the Royal Bank of Scotland, and it aims to solve hyperinflationary token models once and for all. DAFI is a unique platform for its synthetic asset creation and its ability to solve a burning issue in the cryptocurrency market. It has various products to tackle the problems caused by hyperinflation and encourages blockchain projects to mint tokens after depositing a small amount of their total original token supply.
The only thing bothering traders is that it is not possible to monetize tokens on the DAFI exchange. While this helps in sustaining a healthy token economy, it is not doing any good for traders. In recent memory, DAFI has partnered with Gather and Razor and has added many more networks under its belt.
Abra is the OG of synthetic assets. It is without a doubt one of the top protocols leading crypto synthetics worldwide. Founded in 2014, the platform made it possible for users to earn interest on top cryptos and stable coins. It is one of those well-recognized platforms that people from both developed and developing countries respect and use on a regular basis.
The platform elevates user experience by adding different personalized services and packages. Institutional investors can borrow in many forms with flexible loan terms. In terms of liquidity, there is nothing to worry about, as it has deeper liquidity that can give you better prices with less slippage.
Synthetix is a one of a kind protocol that is the backbone to derivatives trading in Defi and crypto. Kwenta is Synthetix’s DEX, which allows you to buy assets from cryptos to real-world physical items like gold. As Synthetix is an ethereum-based protocol, you have to deposit your tokens on Defi platforms like Curve or Uniswap.
In terms of governance, the company had shifted from a not-for-profit foundation to three DAOs in 2020. By enabling users to access all world assets in a censorship-resistant way, Synthetix is among the pack leading synthetic asset protocols in 2021.
Synthetic assets are new possibilities made possible by the maturation of Ethereum and the decentralized finance ecosystem. As more people become aware of how blockchain technology and smart contracts play a role in decentralization, the popularity will undoubtedly increase. It will be interesting to see which platforms gain immense popularity in the future and who makes the most out of this space.
While Bitcoin and the underlying blockchain technology is undeniably a groundbreaking innovation, creating a system of synthetic assets that can mirror real-world assets can be seen as one of the most important applications of the technology. Now is the time to bring the technology to those who could benefit from it
Born and brought up in India, Karthikeya Gutta is a crypto journalist and freelance contributor for ItsBlockchain. He covers various aspects of the industry with in-depth analysis and research. His passion towards blockchain and crypto ecosystem is mainly because he believes it can really change the world and help millions of people.
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