The term ‘synthetic asset’ is used to refer to a mix of assets that have roughly the same value as another asset. Based on the traditional markets, synthetic combines different derivative products, including futures, options, or swaps, that stimulate the underlying assets. Some of the participating assets include indexes, stocks, currencies, commodities, interest rates, and bonds.
For instance, instead of purchasing a stock, an investment firm may decide to buy a call option and later sell a put option on the same stock. The implementation of synthetic assets here enables the firm to use many financial strategies instead of focusing on just one investment asset.
The high-end estimate for the value of all derivative contracts is currently estimated to be upwards of $1.2 quadrillion. That amount is exponentially more massive than the global debt ($215 trillion), global real estate ($217 trillion), the world’s supply of gold ($7.7 trillion), and global stock markets ($73 trillion) combined.
On one side, these derivatives can be used majorly to help get rid of price risk from various assets like commodities to debt. On the flip side, derivatives can exacerbate and promote market inefficiencies, which will, in turn, encourage a zero-sum game among the traders instead of creating actual market value.
The use of derivative products enables investors to earn returns without a physical settlement, transfer risk, arbitrage trade, and hedge against price fluctuations.
What Are Crypto Synthetic Assets?
Crypto-based synthetic assets strive to give users exposure to various assets without having to hold any underlying asset. This can range from fiat currencies like the Japanese Yen or the United States dollar, to commodities like silver and gold. Also, it may include index funds and many other digital assets.
Through the use of these unique synthetic assets, the investors can still hold tokens that track the value of some assets without having to leave the crypto ecosystem. The crypto synthetic assets also ensure that users get all the advantages associated with decentralization.
They are open to all users across multiple borders by using secured smart contracts coupled with other instruments. Interestingly, the data is stored on distributed ledgers.
What Types of Crypto Synthetic Assets Exist?
Abra is one of the popular decentralized investment platforms that let users use their crypto as collateral to create synthetic assets. Abra’s synthetic asset model leverages smart contracts that are enabled with Litecoin and Bitcoin.
Practically, in the case that an investor wants to purchase some Google stock worth around $1,000 through Abra, this firm pegs $1,000 of the user’s BTC against the price of Google’s stock. Whenever Google goes up or down, the equivalent amount of BTC will be added or subtracted from the user’s contract.
In the instance elaborated above, the investor might essentially decide to take a short position on Bitcoin while taking a long position on Google, the hedged asset. In the meantime, Abra would take a long position on BTC while shorting Google.
Synthetix, an Ethereum-based platform, enables investors to mint and also trade synthetic cryptos on its peer-to-peer platform. This strategy lets users gain access to synthetic products that concurrently give them exposure to non-crypto assets, including USD, gold, and stocks.
At the moment, there is over $69 million locked in synthetic derivative contracts. Synthetix, for now, has three decentralized apps. They include; the Synthetic exchange, Mintr. This app allows users to stake the platform’s native SNX token so that they can earn fees and mint Synths. There is also a Dashboard that offers an overview of the whole Synthetix Network.
The entire Synthetix team has set up a multi-tier issuance platform, a type of collateral, and an exchange, developing a market for crypto-backed synthetic assets. Synthetix allows its users to issue a variety of synthetic assets, which include derivatives, fiat, cryptos, and different asset classes. Examples in this category include USD, Bitcoin, Tesla stocks, Euro, gold, and many more.
The user is required to put collateral, in the form of the local SNX tokens to create the synthetic assets. After that, the user can swap or exchange one synthetic asset for another, repricing the collateral via an oracle without an intermediary.
By description, Universal Market Access (UMA) is a decentralized platform serving financial contracts that uses a “provably honest oracle mechanism” together with smart contracts to empower the users to create their financial products.
Thus, UMA users can create various financial products using different protocols like ERC-20 to create tokenized derivatives. These derivatives grant users exposure to real-world underlying assets that are similar to how traditional exchange-traded funds operate.
Why Are Crypto Synthetic Assets Popular?
Crypto-collateralized synthetic currency models powered by smart contracts can have massive implications in the traditional finance industry. In their essence, these models provide crypto holders the leverage that they need to trade traditional assets and their derivatives while remaining within the digital infrastructure the entire time.
Decentralization grants open access to a worldwide community of investors. Before products like UMA, Synthetix, and Abra came about, only a few institutional investors could access the global derivatives markets. At the moment, anyone who owns a smartphone and an intermediate understanding of the synthetic asset operations can access these powerful investment vehicles.
With many crypto synthetic asset platforms opening their doors to derivatives for thousands of new investors, only time will determine the kind of impact that a probable flood of new crypto-collateralized derivatives contracts will have on the traditional financial investment landscape.