What are synthetic assets and how exactly are they important in Defi?

The importance of synthetic assets is found in their capacity to provide exposure to a variety of financial instruments without requiring physical ownership, opening doors to opportunities in conventional markets free from customary limitations. This blog gives a complete understanding on synthetic assets and its significance on Defi. 

What are Synthetic Assets?

Synthetic assets are financial instruments that receive their value from an underlying asset, but do not actually own it. They let users to be exposed to traditional assets, such stocks, commodities, or currencies, without really owning them. They are made using smart contracts on blockchain platforms like Ethereum. Tradeable or investable on decentralized exchanges, these synthetic assets are denoted by tokens.

Synthetic Assets Vs. Traditional Derivatives

Synthetic assets must be distinguished from standard derivatives to fully appreciate their significance in DeFi. Although exposure to the price swings of underlying assets is offered by both synthetic assets and traditional derivatives, there are notable differences in their methods and capabilities.

Complex financial instruments like futures and options, which are normally traded on centralized platforms, are frequently involved in traditional derivatives. On the other hand, smart contracts are used on decentralized blockchain networks to generate and exchange synthetic assets. This important difference reduces counterparty risks and increases accessibility by doing away with the requirement for intermediaries.

Why Are Synthetic Assets Important?

A multitude of advantages are brought about by the introduction of synthetic assets in DeFi, which solve many of the problems that come with traditional financing. In the DeFi space, synthetic assets have become essential for the following main reasons:

Accessibility and Inclusivity: Access to financial instruments is revolutionized by synthetic assets, which enable users worldwide, regardless of location or financial standing, to take advantage of opportunities that were previously unattainable in traditional markets.

Efficiency and Speed: For quicker settlement and to reduce costs and time associated with traditional transactions, DeFi leverages smart contracts and blockchain technology. Through the quick and easy trading of a variety of assets, synthetic assets are essential for increasing DeFi efficiency.

Diversification of Portfolios: Investing becomes easier when portfolios are diversified; complicated methods or several accounts are not necessary. This procedure is still necessary for efficient risk management and investment strategy optimization.

Liquidity and Market Depth: Liquid marketplaces for different assets are made possible by synthetic assets, which increase DeFi liquidity. In addition to improving market depth, this additional liquidity lowers trade slippage.

The Mutual Benefits of Synthetic Assets and DeFi

The mutual benefits that result from the synergy between synthetic assets and DeFi support the expansion and sustainability of both. Some of the mutual benefits are:

Decentralization and Trustlessness: Because of its decentralization, DeFi can create, trade, and settle synthetic assets without the use of conventional middlemen. By reducing the possibility of fraud or manipulation, this trustless system improves security.

Global Reach: Through synthetic assets, DeFi platforms reach audiences worldwide, dismantling conventional obstacles to cross-border transactions. By democratizing access to a range of assets, this accessibility advances financial inclusion.

Innovation and Flexibility: By providing a flexible framework for new financial services and products, synthetic assets encourage innovation in DeFi. This incentivizes users to explore innovative investing strategies and frameworks within a fluid environment.

Importance of Synthetic Assets in the Crypto Industry

Synthetic assets are essential to the way the cryptocurrency market develops going forward. The following salient features underscore the significance of synthetic assets within the wider cryptocurrency landscape:

Market Maturation: Synthetic assets help the cryptocurrency market mature by bridging traditional finance with decentralized technologies. Mainstream acceptability is fueled by this integration, drawing institutional investors and traditional financial players.

Hedging Mechanism: Because digital assets are erratic, synthetic assets are essential for reducing risk for Bitcoin investors. This is a risk management tool that institutional investors entering the Bitcoin market need to have.

Cross-Chain Compatibility: Interoperability between various blockchain networks is essential for the growth of synthetic assets and is required to establish a smooth financial ecosystem that transcends the boundaries of different blockchains.

Applications of Synthetic Tokens

Within the DeFi space, synthetic tokens have a wide range of uses in different areas. The following noteworthy uses highlight the adaptability of synthetic assets:

Tokenized Stocks and Equities: With synthetic tokens, users can trade and invest in tokenized versions of conventional stocks. This gives investors new ways to access international markets without requiring traditional brokerage accounts.

Commodity Exposure: DeFi systems simplify commodity trading by providing customers with synthetic asset exposure to commodities like gold, silver, and oil without requiring physical delivery or storage.

Crypto Index Funds: Building cryptocurrency index funds that provide investors with exposure to a wide range of cryptocurrencies requires the use of synthetic assets. This concept keeps the same structure as conventional financial products.

Use Cases of Synthetic Tokens

Synthetic tokens have uses outside of traditional finance that lead to creative use cases in the DeFi ecosystem:

Stablecoins: Synthetic assets help create algorithmic stablecoins through smart contract techniques, guaranteeing price stability. Users have the choice to switch from traditional fiat-backed systems to decentralized, censorship-resistant value stores.

Leveraged Trading: Leveraged trading using synthetic assets exposes traders to more market volatility, which increases possible gains but also increases risk. This emphasizes how very important using efficient risk management strategies is.

Governance Tokens: Synthetic assets serve as governance tokens in DAOs, giving token holders the ability to vote and make decisions. This helps to support DeFi platforms' democratic governance.

Top 6 Synthetic Asset Protocols

More decentralized finance (DeFi) alternatives have surfaced to fulfill the growing need for synthetic assets. On different blockchains, synthetic asset exchanges—which let traders purchase and sell synthetic assets—have grown in popularity.

Synthetix

A decentralized finance (DeFi) mechanism based on the Ethereum blockchain is called Synthetix. It makes it possible to create "synthetic assets," or "synths," that are equivalent to other real-world assets, such as commodities, fiat money, and cryptocurrencies.

Key Features: SNX tokens are locked up as collateral by users of Synthetix's collateralized debt position (CDP) mechanism in order to mint synthetic assets. Decentralized oracles are also incorporated into the protocol to guarantee precise price feeds for the synthetic assets.

Mirror Protocol

Mirror Protocol is focused on developing artificial assets that mimic the value of real-world assets, especially stocks, and it runs on the Terra blockchain. It seeks to integrate conventional financial assets into the ecosystem that is decentralized.

Key Features: To mint and sell virtual assets, Mirror Protocol makes use of smart contracts. Utilizing the native MIR token, users can take part in governance and liquidity providing. With Terra stablecoin (UST) as its base money, the system benefits from its stability.

UMA (Universal Market Access)

On UMA, a decentralized platform for financial contracts, users can produce and exchange synthetic assets. By facilitating the production of unique synthetic tokens, UMA seeks to enable universal access to financial markets and derivatives.

Key Features: Because of its design, UMA can produce "priceless" synthetic assets without depending on outside oracles. To keep synthetic assets stable, it makes use of a dispute settlement and collateralization process.

Injective Protocol

A decentralized exchange system called Injective system facilitates the production and exchange of synthetic assets. It offers quick and inexpensive transactions via its layer-2 Cosmos zone operation.

Key Features: The focus on decentralized derivatives trading is one of Injective Protocol's most notable features. Synthetic assets that reflect different financial instruments can be created and traded by users. Token staking and governance are handled by the protocol using its native INJ token.

Augur

On the Ethereum blockchain, Augur is a decentralized prediction market platform. Augur lets users construct and exchange prediction market shares, which effectively represent outcomes of real-world events, even if it is not solely focused on synthetic assets.

Key Features: Users of Augur's decentralized oracle system report on the results of occurrences. By staking on the right results, users can gain REP (Reputation) tokens, and the platform makes sure that markets are handled correctly.

dHedge

A decentralized asset management platform called dHedge runs on the Ethereum network. It makes it possible to create and trade synthetic assets that reflect the performance of several traders' portfolios.

Key Features: Traders can establish their own "funds" of synthetic assets, or synths, using dHedge. Then, in order to be exposed to the trading methods of particular fund managers, investors might buy these instruments. DHT (dHedge DAO token), the platform's native cryptocurrency, is utilized for staking and governance.

Risks of Synthetic Assets

Even though synthetic assets have many advantages, it's important to take into account the dangers involved. Some important risks that users need to be aware of are as follows:

Smart Contract Risks: Using smart contracts is risky because of possible flaws and weaknesses that malicious actors could take advantage of. Users need to keep up with security flaws and perform comprehensive audits of smart contracts.

Oracle Risks: Oracles provide accurate and fast price feeds for the underlying assets of synthetic assets; but, in the event that pricing is manipulated or compromised, users may suffer financial losses.

Regulatory Uncertainty: The use and expansion of synthetic assets may be impacted by legal ambiguity and compliance issues in the changing regulatory environment. Consumers ought to keep up with changes to the laws in their areas.

Synthetic assets contribute significantly to the expansion of DeFi within the Bitcoin ecosystem by providing investors with access to genuine assets. Users can now access assets that were previously restricted to traditional marketplaces thanks to innovative financial frameworks. Price oracles and algorithmically created market forces effectively evaluate and protect the synthetic asset value.

With more than ten years of experience in blockchain technology, Osiz Technologies is a top DeFi development company. Its team of talented blockchain architects and DeFi developers can provide top-notch protocols for the creation and trading of synthetic assets.