According to the Synthetix white paper, Synthetix is a decentralized synthetic asset issuance protocol built on Ethereum. What this means is that the Synthetix network allows people to create synthetic assets, or “synths”.
Synthetic assets are the decentralized finance (DeFi) equivalent of derivatives in traditional finance. Synths take the form of ERC-20 smart contracts that track the returns of a real asset without requiring investors to own that asset. In effect, it can be said that an investor can gain “synthetic” exposure to regular assets in this fashion.
How Do Synths Work?
A synth is a virtual representation of another asset in the form of an ERC-20 smart contract. The smart contract serves to tie the price of the synth to the asset.
Synths can be traded on Kwenta, Synthetix’s decentralized exchange (DEX), and can represent cryptocurrencies, indexes, gold, and more.
Synths utilize decentralized “oracles”, which are price discovery protocols based on smart contracts. These oracles automatically track the price of the asset that a synth represents, allowing investors to hold a synth as if it were actually the underlying asset.
In this way, synths can give crypto investors exposure to assets they wouldn’t normally be able to access through the cryptocurrency ecosystem, such as gold and silver.
Synths are issued on Ethereum, which means users can deposit them on other decentralized finance platforms and earn interest. Some participants in this newly emerging financial system believe that synthetic assets and derivatives are important for the space to mature and become legitimized, as synths and derivatives can help hedge against volatility and facilitate price discovery.
Recommended: What is Ethereum and How Does it Work?
Synths vs Tokenized Commodities
Synths differ from tokenized commodities like Pax Gold (PAXG), created by Paxos, a cryptocurrency backed by physical gold bars. Holding PAXG is intended to give investors a piece of an actual gold bar—someone who holds PAXG has a claim on physical gold that Paxos is holding.
Synths, by contrast, only provide exposure to the price of the underlying asset. For example, a synth for gold would give investors a token they could hold that would mimic the price of gold.
How Does Synthetix Exchange Work?
Users can trade synths on Kwenta, the decentralized exchange (DEX) for Synthetix, as well as across a variety of different DeFi protocols. Unlike other exchanges, Kwenta has no order book that contains buy and sell orders. Instead, Kwenta uses peer-to-contract trading, meaning all trades get executed via smart contracts.
Proponents of Synthetix claim this type of exchange has a few key advantages.
Infinite liquidity: Traders don’t have to worry about “slippage,” or driving prices down when they place large sell orders, reducing their overall profits.
Censorship resistance: Since the system is decentralized and governed by smart contracts, it is free and open to everyone (and resistant to censorship). In fact, users don’t even have to create an account to start using Kwenta.
Oracles from another DeFi protocol called Chainlink (LINK) provide the price feeds that set exchange rates for each synthetic asset. This differs from traditional exchanges, where prices are determined by the point at which buyers and sellers are willing to meet. Trades come with fees of between 0.3% and 1%, and the proceeds get sent to a pool where SNX stakers claim them as rewards for staking tokens.
Is Synthetix a Good Investment?
As with all altcoins, trading SNX can be highly volatile and is widely considered to be a speculative investment.
There are thousands of altcoins, and over the years many of them have seen their values fall to zero or very close to it. These coins tend to make a few people large profits during the speculative mania phase, and may bring large losses to everyone else afterward, so investors should exercise caution before trading altcoins.
Some investors might believe that certain cryptocurrency projects like Synthetix have the potential to grow into something large and significant in the future. It’s possible that DeFi protocols like Synthetix could wind up becoming part of a new financial system, in which case the SNX token might perform well.
It’s also possible that some DeFi protocols could fail for various reasons, in which case SNX and other tokens like it could fail to be a good investment.
Recommended: 2021 Guide to Crypto Trading
How Do You Make Money on Synthetix?
There are a few ways to potentially profit from Synthetix.
Buy SNX, the Synthetix network token, on an exchange. If the price rises, then a profit will be realized.
Trade synthetic assets on Kwenta. If a trader holds synthetic gold or Bitcoin, for example, and the price of those assets rise, then the price of the synths should also rise.
Users can stake their SNX tokens and earn passive income rewards on a regular basis.
How Do You Trade On Synthetix?
There are two ways to start trading synths.
A user can purchase ETH on an exchange before exchanging that ETH for sUSD on Kwenta. The sUSD can then be exchanged for other synths.
A user can obtain SNX tokens on an exchange, then stake their SNX on a decentralized application created by Synthetix called Mintr. At this point, users can create synths and start trading them on Kwenta.
As of March 2021, Kwenta users have the option to trade 13 different cryptocurrencies and their inverse counterparts (inverse cryptocurrencies inversely track the price of cryptocurrencies, providing a way to short them), synthetic gold and silver, and several synthetic government-issued fiat currencies. The Synthetix website lists five categories of synths, including commodities, fiat currencies, cryptocurrencies, inverse cryptocurrencies, and cryptocurrency indexes.
There are also two synthetic cryptocurrency indexes offered by Synthetix: sDEFI, an index that tracks a basket of DeFi assets, and sCEX, which tracks a basket of exchange tokens (e.g., Binance coin).
The Takeaway
Synthetix enables cryptocurrency users to invest in certain assets via proxy mechanisms called synthetics or “synths” for short. Powered by the Synthetix network token (SNX), users can create their own synths and trade them on a decentralized exchange. To create synths, users must stake a certain amount of SNX to collateralize the new synthetic assets.
Photo credit: iStock/visualspace
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