What are synthetic tokens and how do they work? In this quick DeFi 101 article, synthetic assets are explained in the fastest and simplest way possible. If you really want to be the blockchain whizz of your trading group, then you need to know everything about crypto’s most promising asset group.
Decentralized Finance, or DeFi for short, is turning everything we know about money upside down. While many DeFi concepts and products seem familiar, like exchanges, lending, and swapping, the openness of blockchain means we can explore truly novel territory.
For the leading example of just how much of a new financial paradigm DeFi represents, look no further than synthetic assets.
Sometimes referred to as synths, synthetic assets are blockchain-based cryptocurrency derivatives that act and feel like traditional derivatives, but are far from normal.
What are synthetic assets in DeFi?
Despite sounding confusing and kind of sci-fi, synthetic assets aren't all too difficult to wrap your head around.
To understand synthetic assets, the first thing to know is that they're derivatives.
Let's define what derivatives are. A derivative is any asset that derives its value from an underlying asset or index.
Suppose a derivative's value is tied to the value of another asset via a contract. In that case, we can trade the movement of that value using trading products like futures and perpetuals.
How do synthetic assets differ from traditional derivatives like futures?
Instead of using contracts to create the chain between an underlying asset, the derivative product, synthetic assets tokenize the relationship. This means that synthetic assets can impart exposure to any asset in the world — all from within the crypto ecosystem.
A synthetic asset is simply a tokenized derivative that mimics the value of another asset.
Imagine that you want to trade Gamestop stocks without holding the $GME asset itself. Using a synthetic, you can trade $sGME (synthetic GME) instead, which behaves like the underlying asset by tracking its price using data oracles such as Chainlink.
Advantages of crypto synthetic assets vs. traditional derivatives
Traditional derivatives were once groundbreaking in their ability to unlock additional value from assets like equities. However, crypto synthetic assets are taking liquidity access to a whole new level.
Here are just a few advantages synthetic assets have over traditional derivatives:
Anyone can issue them: Blockchain-based synthetic assets can be minted by anyone using open-source protocols like Synthetix and Mirror.
Worldwide liquidity: Synthetics can be traded on any crypto exchange in the world, including unstoppable decentralized exchanges.
Borderless transfers: Synthetic assets are blockchain assets like ERC-20 tokens; you can send and receive them between standard cryptocurrency wallets.
Frictionless movement: Switch between equities, synthetic silver/gold, and other assets without having to hold the underlying asset.
Generally speaking, synthetic assets enable far more liquidity across global exchanges, swap protocols, and wallets than traditional derivatives are even remotely capable of.
Synthetic assets make tokenizing and trading anything a reality
The sheer power of crypto synthetic assets becomes more obvious the closer you look.
Imagine that anything — not just assets like equities — can be represented as a synthetic asset token and, therefore, be brought onto the blockchain.
By enabling anything to be tokenized and brought onto the blockchain, synthetic assets unlock untold pools of global liquidity.
Apart from simple market buying/selling and derivatives trading, synthetic assets create possibilities for seemingly infinite markets and combinations for new sources of value.
Imagine a synthetic asset token that tracks corporate co2 emissions in an industrial zone.
When emissions rise, token holders (these may be locals living nearby, city officials, and outside speculators) profit as the companies issue co2 tokens. However, when emissions decrease, the companies profit by retaining tokens, incentivizing them to continually reduce co2 emissions.
Synthetic asset-based markets like these are just some of the ways synthetics break trade out of the mold.
Trading synthetic stocks using Synthetix and Mirror Protocol
Crypto synthetic assets are already trading in familiar ways, making them approachable to anyone already familiar with trading equities and/or crypto.
Today, there are a few synthetic asset exchanges, but none are as established as Synthetix and Mirror Protocol.
Synthetix.io: Decentralized synthetic asset exchange protocol enabling anyone to mint, exchange, and provide liquidity for a vast range of assets.
Mirror.finance: Synthetic asset protocol for creating & exchanging fungible tokens tracking the price of off and cross-chain assets.
Using Synthetix or Mirror to trade stocks like $AAPL $TSLA $TWTR $AMZN is easier than you might imagine. The way it works is simple.
Users mint (create) synthetic assets by depositing collateral (SNX for Synthetix, UST for Mirror). The collateral is used to back the minted synthetic asset with real value.
Oracles feed the target asset’s price to the platform in real-time, enabling the synthetic to track value accurately.
Traders use Synthetix or Mirror to trade assets like mBTC (mirrored Bitcoin), sUSD (synthetic USD), or popular equities like mGME (mirrored Gamestop).
Minters retain a reward for minting and creating liquidity for exchange-traded assets paid in the protocol's native asset (SNX or MIR).
The biggest advantage to trading crypto synthetic assets over ordinary equities on exchange apps like Robinhood is simple: synthetics give you unlimited, uncensored, and instant access to any asset imaginable.
Upcoming synthetic asset exchanges and protocols
We've mentioned Synthetix and Mirror protocol as the current market leaders for synthetic asset exchange, but we'd be remiss not to mention newcomers.