Synthetic Assets in DeFi: What You Need To Know

Marcel Deer
By Marcel Deer
Joel Taylor
Edited by Joel Taylor

Published July 19, 2022.

Falling gold and silver coins on black background

Much of the terminology in the crypto and decentralized finance space leaves us scratching our heads—and synthetic assets are one of them. So, what are synthetic assets in DeFi?

Crypto-based synthetic assets are designed to expose users to various assets without needing to hold the underlying asset. Think fiat currency, i.e., the United States dollar or the Japanese yen; or other commodities such as gold, real estate, index funds, or digital assets.

How Synthetic Assets Work

Synthetic assets are commonly referred to as “synths" and are an excellent option when buying crypto—one of many purchasing options to have surfaced since the beginning of DeFi.

Utilizing these unique assets allow investors to hold tokens capable of tracking the value of certain assets without being required to leave the crypto ecosystem. These synthetic assets also benefit decentralization since they are open to all users using smart contracts and other methods. The data is stored on distributed ledgers.

The removal of third parties offers less room for error and dishonesty. In addition, the unbiased nature of smart contracts allows transactions to be performed reliably and correctly. Instead of centralized authorities, a public ledger records and verifies all transactions on the blockchain for everyone to view. A ledger creates more transparency and empowers investors to instantly access, trade, and transfer assets simply and easily.

A synthetic asset is a tokenized derivative mimicking the value of another asset. The best thing about trading synthetic assets is that synths provide users unlimited and uncensored access to virtually any asset with few restrictions.

Advantages of Synthetic Assets

There are quite a few benefits to synthetic assets compared to traditional derivatives, such as the following:

  • Anyone can issue them Blockchain-based synthetic assets can be minted by anyone, doing so by using open-source protocols.
  • Worldwide liquidity Synths can be traded on virtually any crypto exchange.
  • Borderless transfers Synths are blockchain assets, meaning you can send and receive between standard crypto wallets.
  • Smooth movement Users can switch between equities easily. I.e., precious metals, real estate, and various other assets without holding the underlying asset.

Synths are undoubtedly groundbreaking. They can be considered one of the key features of DeFi, allowing financial markets to become borderless, expand and grow more prominent, and reduce capital requirements. On the other hand, even though synthetic assets are a helpful instrument for the industry, they are naturally somewhat risky.

Issues With Synthetic Assets

Perhaps the biggest drawback of synths is that they never grant ownership of the underlying asset. Traders can earn profit and get exposure to the price of an asset, but this is only a representation of the tangible asset itself.

Synthetic asset holders don’t typically obtain votes, access to dividends, or other shareholder rights. Scalability may also pose an issue since the decentralized finance space is still in an experimental phase.

A complicated user interface tends to be an issue with many larger platforms and is unappealing to newer users. Security is another inevitable problem: even though most of these platforms are audited, there have been, and probably always will be, hacker attacks.

Best Synthetic Asset Platforms

The market leader in synth exchange would likely be Synthetix, with over $1.8 billion in total locked value. However, there are also newer platforms in the space, such as:

  • Mirror Protocol On-chain price exposure to real-world assets for all.
  • UMA Synths for the DeFi ecosystem.
  • Linear Finance Exchange protocol for liquid assets.
  • Balance DAO Synths are built on Icon, which ICX backs.
  • Deus Finance Synthetic creation and trading, which is Ethereum-based.

Conclusion: Synthetic Assets in DeFi

Synths are revolutionizing the DeFi space by providing investors with access and liquidity. Tokenization allows users to access various investment opportunities. Since transactions are managed on the blockchain and executed via smart contracts, entering and exiting from investments with almost immediate liquidity is made simple for everyone.

You must research beforehand and find a suitable platform for your needs. Knowledge is power, and it’s best to equip yourself before investing in synthetic assets or getting started on an exchange platform.