By Ryan O'Neill
Crypto Synthetic Assets Explained
Crypto synthetic assets represent a different category of digital financial instruments designed to reproduce tangible assets’ value and features. These financial tools extend beyond traditional stocks, commodities, and fiat currencies to diverse crypto assets without the direct possession of the original tokens.
Also known as synthetic assets, these classes of digital finance instruments are expertly designed via derivatives and smart contracts within an underlying blockchain protocol, mainly decentralized finance (DeFi) platforms. Moreover, the ability to create decentralized smart contracts on networks like Ethereum requires the adoption of collateral to ensure value addition.
It also includes the capacity to assess target asset values and shape derivative products accurately. In the DeFi ecosystem, customers can now enjoy broad access to multiple financial markets and assets.
However, users must exercise caution by recognizing the complexities of the tools and their inherent risks. Hence, understanding their fundamental mechanism and associated impact on investment plans is vital.
Comparing Conventional And Crypto Synthetic Assets
Traditional financial instruments include tangible or monetary products like stocks, commodities, bonds or other traded assets in established institutions. On the other hand, crypto synthetic assets are the virtual versions of the conventional financial products created on blockchain technology.
Another difference between the two lies in traditional assets’ physical or paper-based nature, while crypto synthetic assets exist solely in digital formats within blockchain protocols. In addition, the crypto version offers added benefits in terms of liquidity, accessibility and diverse programs compared to the traditional one with its accompanying risks.
Forms Of Crypto Synthetic Assets
Several types of cryptocurrency-based synthetic assets include:
- Tokenized commodities and equities.
- Synthetic stablecoins.
- Leveraged and inverse tokens.
- Yield-bearing synthetic assets.
Tokenized Commodities And Equities
These financial tools represent tangible assets like gold, stocks, oils and other commodities hosted on blockchain networks. Tokenized commodities and stocks facilitate decentralized fractional ownership and transfer of traditional investments.
One notable example is the synthetic asset on the Synthetix platform, sOIL. This asset typifies the price fluctuations of crude oil in real-time.
Additionally, it exposes investors to crude oil prices and market trajectory without possessing any physical oil.
Synthetic Stablecoins
A synthetic stablecoin is a class of digital tokens that mirrors the value and stability of assets pegged to fiat currencies like the USD or Euro. Synthetic stablecoins offer investors the means to trade goods and services with value pegged to fiat currencies without being subjected to the price volatility of crypto assets.
An example of a synthetic stablecoin is the sUSD.
Leverage And Inverse Token
Leverage and inverse tokens amplify or stabilize the price dynamics of underlying assets. Accordingly, inverse tokens gain when an underlying asset’s price declines, while leverage permits expanded profits and losses.
Yield-bearing Synthetic Assets
The decentralized finance ecosystem gives yield-bearing asset holders returns via staking or lending of digital assets. This allows traders to generate passive incomes as their tokens multiply.
Crypto Synthetic Assets Use Cases
Trading And Investing
Crypto synthetic assets allow for diverse investment and trading opportunities. They enable traders to engage in leveraged transactions by increasing their exposures to market fluctuations, resulting in massive profits or losses.
It is worth noting that synthetic assets encompass various underlying assets within the crypto market. They also include stocks and commodities, providing investors with a seamless way to diversify their investment portfolios.
Yield Farming And Liquidity
Traders who stake crypto synthetic assets in the decentralized finance ecosystem can use yield farming to earn incentives through governance tokens. Moreover, synthetic assets can contribute to increased liquidity pools and the overall Liquidity of DeFi platforms.
This is essential in facilitating active trade, borrowing and lending activities within the DeFi space.
Risk Management And Hedging Opportunities
Synthetic assets also provide a robust risk management instrument and hedging opportunities for traders and investors. Additionally, synthetic stablecoins offer another decentralized option to traditional stablecoins by protecting the value of tokens amid the inherent market volatility.
Benefits Of Crypto Synthetic Assets
Cryptographic synthetic assets offer immense benefits in the digital finance realm. Their most important use is providing users access to various tokens, including traditional stocks, fiat currencies and commodities.
These assets also allow traders to leverage and increase their exposure to the underlying token’s price volatility and generate high profits.
Challenges Associated With Crypto Synthetic Assets
Adopting synthetic assets in the crypto and blockchain space has risks that traders must carefully assess. Crypto synthetic assets are prone to smart contract exploits, which might lead to high-profile losses, as in the 2016 infamous DAO attack.
The exploit was due to bright contract flaws that resulted in the loss of Ether worth $50 million. Inadequate market liquidity is another issue that keeps affecting some synthetic assets.
Also, some of these assets need more liquidity than their traditional finance ecosystem counterparts. This could lead to price manipulation during trading and affect the broader market’s stability.
Moreover, regulatory oversights have been a reoccurring concern to market players as governments struggle with performing oversight functions regarding this industry.