Synthetix is leading the vanguard of the DeFi revolution — but what is it, and how does it work?
The decentralized finance, or DeFi ecosystem consists of many different projects and platforms. Few have achieved the success and reach of Synthetix, which currently operates as one of the most widely-adopted distributed asset issuance protocols within the blockchain ecosystem.
Synthetic is a decentralized platform built on the Ethereum network that allows participants to issue or completely decentralized synthetic assets. Using Synthetix, it’s possible to trade cryptocurrencies and fiat currencies, as well as commodities or any asset that can be adequately collateralized.
In simple terms, Synthetix is a decentralized platform that allows users to create and trade synthetic assets. Understanding what Synthetix is and how it works, however, can get complicated. Here’s everything you need to know about Synthetix.
Synthetix and DeFi
The core offering of the cryptocurrency and blockchain revolution was the promise of a truly decentralized means of issuing, transacting, and storing value within a universally accepted system. Cryptocurrencies allow anybody to transmit value to anybody else, regardless of location and with minimal fees.
Satoshi Nakamoto, the pseudonymous creator of the Bitcoin blockchain, envisioned cryptocurrency as a “purely peer-to-peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution.”
The rapid evolution of the blockchain ecosystem has greatly expanded the initial scope of cryptocurrency as a means of transferring value. The decentralized finance ecosystem, typically shortened to DeFi, now promises to bring any kind of financial service imaginable onto the blockchain — without the need for intermediaries, centralized financial institutions, or middlemen.
DeFi aims to offer decentralized loans, investments, insurance products, savings accounts, and much more. By bringing these services onto the blockchain, DeFi creates accessible financial ecosystems that can be accessed by anyone from anywhere.
The foundation of DeFi is the applications of smart contracts — applications that exist on blockchains that integrate a virtual machine, such as the Ethereum blockchain. Smart contracts allow developers to create sophisticated decentralized applications that offer far more functionality than simple cryptocurrency transactions.
A key feature of the Ethereum blockchain upon which Synthetix operates is the ability to create new tokens that exist on top of the Ethereum blockchain itself. By combining smart contracts and the possibility of creating new blockchain tokens, Synthetix aims to create a new paradigm in asset issuance and exchange.
What is Synthetix?
Synthetix operates on the Ethereum blockchain and is designed to allow for the creation and trade of synthetic assets. In simple terms, synthetic assets in the context of blockchain technology refer to a combination of securities, assets, or tokens that produce the same effect as owning another asset. Synthetic assets represent assets that do not exist on a blockchain, on-chain — but proving the collateralization of these assets can be difficult.
The synthetic assets issued via Synthetix can be used to track the price of any other asset, or represent real-world assets. Synthetix assets can represent bonds, commodities, equities, other cryptocurrencies, or even real estate. If an asset has real-world value, it’s possible to use Synthetix to create a synthetic asset that tracks its price.
The mechanism used by Synthetix to maintain the value of synthetic assets is similar to those used by stablecoins such as USD Coin or Tether to maintain value. Rather than maintain the value of a single stablecoin, however, these mechanisms are used to create an ecosystem in which anyone can create a synthetic asset, backed by the Synthetix SNX token.
The Synthetix ecosystem is driven by two different types of token. The first, SNX, is the primary token used in the creation of synthetic assets issued within the Synthetix ecosystem. The second type of token, the Synth, refers to every different synthetic asset token created within the Synthetix ecosystem.
At a glance, the Synthetix ecosystem is relatively straightforward. In order to get started with Synthetix, users must purchase SNX from an exchange that lists SNX trading pairs and then lock them in a wallet compatible with the Synthetix platform. After locking SNX tokens, the value they represent can be used to create Synths that track the real-world value of another asset.
Understanding how Synthetix determines the price of each individual Synth, however, can get a little more complicated. Synthetix uses oracles to determine Synth prices, most of which are provided through a partnership with Chainlink (LINK). Oracles connect blockchain networks to off-chain resources and systems.
Currently, most of the Synths available for trade within the Synthetix ecosystem are fiat currency or cryptocurrency pairs. There are also a number of Synths based on the price of precious metals such as gold and silver — all of these Synths can be traded via the Synthetix Exchange.
The programmable nature of Synths allows issuers to create unique tokens — sBTC, for example, is a Synth that tracks the price of Bitcoin. iBTC, however, is a Synth that operates in an inverse manner, gaining value when the price of Bitcoin falls.
These applications represent the most basic use cases of Synths within the Synthetix ecosystem. The programmable nature of Synths, however, makes it possible to create entirely new types of assets, allowing users to create Synths that represent portfolios of assets, hedge against market movements, or create complex payment systems.
The four unique features of Synthetix that are key differentiators between SNX and other cryptocurrencies are as follows:
● Synthetix allows anybody to create Synths without the need for counterparties
● Synths are fungible — any Synth can be traded for any other Synth via the Synthetix exchange, with virtually infinite liquidity
● The Synthetix ecosystem eliminates the need for an orderbook due to the integration of Peer-to-Contract trading
● Collateral is provided by a decentralized pool of token holders, who maintain stability within the Synthetix Exchange
What Can You Trade on Synthetix?
The assets that can be traded on Synthetix include Synths and inverse synths of major fiat currencies such as Euro, USD, AUD, Yen, Pound Sterling, and the Swiss Franc. It’s also possible to trade both normal Synths and inverse Synths of most major cryptocurrencies, such as Bitcoin, Ethereum, Ripple, Chainlink, and Tron. Synths and inverse Synths of gold and silver can also be traded via Synthetix.
The Synthetix ecosystem allows users to trade virtually any asset. It’s possible to create and trade Synths that track the price of any number of commodities, equities, derivatives, or other assets within the traditional financial system. All of these assets can be collateralized, issued, and traded within the Synthetix ecosystem.
The use cases of Synthetix trading are far-reaching. Using Synthetix, for example, it’s possible for anyone in the world to trade global equities without needing to deal with the administrative friction caused by government regulations or centralized financial institutions.
How Does Synthetix Ensure Collateralization?
Collateralization is the biggest obstacle faced by blockchain platforms that aim to digitize assets and bring them onto the blockchain. In order to ensure that the Synthetix ecosystem is stable, the Synthetix protocol must ensure that the value of Synths issued are accurate and up to date with the value of the assets they represent.
The liquidity mechanism that drives Synthetix collateralization is designed to overcome the collateralization problem. When a Synthetix user wants to mint a new Synth, the user must collateralize 750 percent of the value of the issued token. A User that wants to mint 100 synthetic AUD, for example, must therefore lock up the equivalent of $750 in SNX token in order to mint an AUD Synth.
This collateralization mechanism creates a large liquidity buffer for all Synths in circulation and prevents the Synthetix ecosystem from being disrupted by large market movements.
Synthetix Debt Pools
The system that governs the issuance of Synths within Synthetix is debt-driven — whenever Synths are minted, SNX collateral is locked up. The Synths issued then take on the form of outstanding debt within the Synthetix platform. Should a user want to unlock the SNX tokens they have locked up as collateral, they must burn — a term that refers to permanently destroying a blockchain token — a number of the issued Synths in equal value to the SNX they want to unlock.
The 750 percent collateralization mechanism ensures that it’s easier for users to burn Synths and reclaim their locked SNX tokens should they choose to do so.
An individual that issues synths therefore takes on personal debt for the Syths they mint — but the entire circulation of Synths on the Synthetix platform is driven by a global debt pool. Individual debts on the Synthetix platform are calculated as a dynamic percentage of the Synths minted by the user currently in circulation, as well as the exchange rate of the asset represented by the Synth and the value of the SNX token.
This ensures that issuers of Synths are not obligated to repay the debt their Synths represent with the exact type of Synth that was originally minted. Users can burn any type of Synth that holds an equal value to the SNX they wish to reclaim.
This mechanism allows the Synthetix platform to claim “infinite liquidity” — any Synth can be burned in lieu of another to reclaim SNX locked up in the issuance of Synths without imbalancing the Synthetix ecosystem.
The Synthetix Exchange
The Synthetix Exchange is the primary point of contact with the Synthetix ecosystem for most users, and allows users to trade the Synth created by other users. The Synthetix Exchange is driven by smart contracts, which eliminates the need for counterparties or third parties within the exchange.
Using the Synthetix Exchange, anybody can buy or sell Synths at any time from anywhere, with unlimited liquidity due to the collateralization mechanism. Using the Synthetix Exchange is relatively straightforward — users connect any web3 wallet to the platform, which makes it easy to trade between Synths and SNX tokens. Synthetic Exchange trading fees are set at 0.3 percent.
The Synthetix model integrates an inflation element — unlike Bitcoin, which has a fixed amount of tokens, the total amount of SNX tokens will be increased from the initial release of 100 million tokens to 250 million tokens by 2025.
The inflation feature present within the Synthetix tokenomic model was introduced in response to indicators that exchange fees alone are an insufficient incentive to issue Synth. Users that create Synth will be provided with SNX from the inflation mechanism, providing an additional incentive to participate in the Synth issuance system.
How Does Synthetix Staking Work?
Synthetix allows anybody to purchase SNX, lock it in a wallet, and create Synth. When a user locks SNX in order to mint Synth, they become a “staker” in the Synthetix ecosystem and earn staking rewards. These rewards are distributed from the proceeds generated by Synthetix Exchange trading fees.
When Synthetix Exchange users trade Synth or SNX, the fees collected are placed in a pool. The SNX contained in this pool are distributed to Synth issuers in proportion to the total amount of outstanding debt they hold. By creating new Synth and taking on more debt within the Synthetix ecosystem, Synth issuers are able to increase the amount of staking rewards they earn.
What is Mintr?
Mintr is a decentralized application, or dApp, designed to provide users with a streamlined and intuitive interface that can be used to manage SNX, Synths, and other features of the Synthetix platform. Mintr allows users to perform tasks that include staking SNX, minting Synth, burning Synth to recover locked SNX, or collect taking fees.
The Future of Synthetix
Synthetix presents a wide variety of use cases. There are, however, a number of issues that must be overcome before the Synthetix platform is robust enough to facilitate financial services on the same scale as traditional financial ecosystems.
Extreme market movements, for example, could potentially create situations in which a Synth issuer would be required to burn more Synths than they originally issued in order to unlock SNX collateral.
The Synthetix ecosystem is also heavily reliant on the Ethereum blockchain, which is subject to scalability issues that prevent it from executing transactions as fast as some traditional fiat currency financial networks until significant network upgrades are complete.
While Synthetix presents a framework for the issuance of Synths that track the price of complex financial products, the creation of these complex Synth tokens necessitates the development of oracle solutions that are able to reliably track asset prices without manipulation or centralization.
Synthetix is one of the largest and most powerful applications of blockchain technology within the decentralized finance ecosystem and is positioned to provide access to truly decentralized financial products to anybody in the world.
While Synthetix is a highly promising platform, current limitations of blockchain technology and interoperability between traditional financial systems preclude the issuance of complex financial product Synths until oracle solutions are developed and integrated with the platform.
The programmable nature of Synth tokens, however, presents a wide variety of use cases within the cryptocurrency market, allowing crypto traders to invest in or trade cryptocurrency in innovative ways.
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