What Are Synthetic Assets in Crypto

What Are Synthetic Assets in Crypto?

Synthetic assets have been a concept in the traditional financial markets for decades. Today, you can also find them in the crypto asset markets.

Read on to find out what crypto synthetic assets are, how they work, and the types of synthetic assets you can find in the market.

What Are Crypto Synthetic Assets?

Often referred to as "synths," crypto synthetic assets are blockchain-powered financial instruments created to mirror the characteristics and value of financial assets. These assets can have commodities, fiat currencies, indices, stocks, and other digital currencies as the underlying assets.

Crypto synths are tokens generated using smart contracts and function similarly to traditional derivatives with the key difference being that they operate on a blockchain and are typically globally accessible.

Today, crypto synthetic assets are becoming more popular in the DeFi space as they allow users to gain indirect exposure to tokenized real-world assets (RWAs).

How Do Synthetic Assets in Crypto Work?

A dedicated synthetic token is created - typically on a DeFi protocol - to track the performance and value of a specific asset or basket of assets.

To create a synthetic token, you must first find a platform that supports the creation and trading of crypto synthetic assets. Synthetix, Mirror Protocol, Balancer, DerivaDEX, and Kine Protocol are some platforms that support the development and trading of synths.

Next, you'll need to choose the underlying asset for the synthetic asset crypto token. This can include commodities, indices, stocks, and other digital currencies.

Once done, proceed to deposit the collateral, which acts as security and guarantees the value of the synth token. The collateral is usually the protocol's native token. For instance, if the platform is an Ethereum-based protocol, users must deposit ether (ETH) as collateral.

Once the collateral has been deposited, a smart contract creates the synthetic asset crypto token and allocates it a value based on the underlying asset(s) it represents. This process is known as minting.

Since the value of the synth token is typically linked to the price of the selected underlying asset, once the token is developed, its value is dictated by the market demand for the underlying asset(s).

If the market demand for the underlying asset surges, the value of the synthetic asset crypto token should also rise. If the demand decreases, so should the value of the synth token.

Types of Synthetic Assets in Crypto

There are numerous types of crypto synthetic assets designed to cater to the varying needs of investors. Let's look at the most popular types.

Synthetic Commodities

Synthetic commodities are synthetic assets that imitate the value of commodities like gold, silver, and oil. sXAU is an excellent example of a synthetic gold token that tracks the price of gold and is powered by the Synthetix protocol.

Synthetic Currencies

Synthetic currencies are synths that mirror the value of fiat currencies such as the euro, US dollar, or yen. A good example of a synthetic currency is sUSD, which tracks the US dollar price and, like sXAU, is enabled by the Synthetix protocol.

Synthetic Stocks

Synthetic stocks are synthetic assets crypto tokens that track various stocks and stock indices globally. sTSLA is an example of a synthetic stock token that mimics the Tesla stock.

Leveraged and Inverse Tokens

These crypto synthetic assets balance or boost the underlying asset's price shifts. The former profits when an asset gains, while the latter grows profits and losses. A good example of a leveraged synthetic token is Binance's BTC3L token.

Yield-Bearing Synthetic Assets

As their name suggests, yield-bearing synthetic assets crypto tokens earn investors yield by lending or stacking their holdings. cUSDC is an excellent example of a yield-bearing synthetic token.

Why Are Synthetic Crypto Assets Important?

While the DeFi sector offers users exciting possibilities, it's still evolving. As such, the number of financial instruments is still limited compared to the traditional financial (TradFi) sector. In TradFi, investors can access various financial instruments, allowing them to incorporate diverse strategies by consolidating different assets.

Synthetic assets have emerged as a solution in decentralized finance to expand the availability of financial instruments and address the limitations of investment strategies in the crypto space.

Crypto synthetic asset platforms also allow the development of real-world asset (RWA) tokenization, which can enable fractional ownership of otherwise largely inaccessible, illiquid assets for retail investors.

Synthetic asset protocols also attempt to address challenges linked with weak cross-chain communication networks. These protocols aim to enable smooth interaction and value transfer between various blockchain networks, allowing them to become interoperable. As a result, this greatly expands the potential for DeFi users.

Examples of Synthetic Crypto Asset Projects

Numerous projects have emerged to serve the growing demand for synthetic crypto asset tokens in the DeFi space. These platforms enable users to buy, sell, and trade synth tokens across various blockchain networks.

Here are examples of two popular synthetic asset platforms:

• Synthetix: Synthetix is currently the leading DeFi protocol that supports the development and trading of synthetic crypto assets on the Ethereum blockchain. Users can create a wide array of synthetic assets and trade them on Kwenta, Synthetix's decentralized exchange (DEX).
• Universal Market Access (UMA): UMA is another protocol that supports the creation of crypto synthetic assets via its 'Priceless' synthetic token structure. Users can design and customize their synthetic assets based on other cryptocurrencies or real-world assets.

The Takeaway

Synthetic assets crypto tokens are helping bridge the gap between TradFi and DeFi instruments by expanding the availability of financial instruments and investment strategies within the crypto ecosystem. They offer investors an avenue to trade a wide array of assets without direct ownership, improving flexibility and financial versatility.

As crypto synthetic assets are relatively new, investors should conduct their own research or consult an expert to better understand the risks associated with synthetic asset crypto tokens before opting to invest.

Sign up for Samara's Monthly Market Commentary to stay current with the latest trends and developments in Bitcoin and tech-driven alternative assets.

FAQs

How to create a synthetic asset?

To create a synthetic asset, you will need to find a platform that supports the creation of synthetic assets, such as Synthetix, choose the underlying asset, deposit collateral to back the synth token, and utilize a smart contract to generate the crypto synthetic asset.

What are synthetic assets vs derivatives?

Synthetic assets are a type of derivative. A derivative is an investment vehicle that receives its value from an underlying asset. A synthetic asset will enable you to trade or hold an asset without directly owning it.

‍