Synthetix: what's at stake?
An article for new SNX stakers and everyone who wants to improve their understanding of what it means to stake SNX and manage debt within the context of Decentralized Finance (DeFi). The first part of this article explains staking SNX in general, while in the second part we follow the journey of Bob, a new SNX staker.
Staking
People who are new to SNX are also new to Decentralized Finance (DeFi) and its concepts. Within this context, "Staking" is a non-trivial concept.
The act of staking basically involves locking up a certain amount of tokens for a period of time with the intent to make money. When you stake a token, you are putting up risk in hope that the reward you receive is greater than the amount of money you put "at stake". (source: Reddit).
Risk
At first glance one might think that staking SNX is simply a matter of "setting and forgetting"; just stake your SNX tokens and return at a later point in time to realize a guaranteed profit. However, the reality of staking in general is that there is no such thing as a guaranteed "free lunch". Staking any token within the crypto space involves a high amount of risk mainly caused by:
- systemic risk; eg. a hacker exploits a bug in a smart contract stealing tokens
- environmental risk; eg. sudden increase of regulatory scrutiny
- high market volatility; eg. BTC drops 50% all of a sudden during a short time frame (24 hours) dragging every token downwards
- opportunity costs; while staking the amount of tokens at stake is locked, you can't use that amount of resources for other investments
A SNX staker’s user journey
Meet Bullish Bob
Bob is feeling very bullish on SNX after watching numerous YouTube videos of Kain explaining what SNX is about. At a market rate of $10 per 1 SNX token Bob buys the dip acquiring 1000SNX through his Centralized Exchange (CEX) Binance. As a next step Bob withdraws the 1000SNX from Binance to his own Ethereum wallet.
For Bob, owning his own tokens is important because through his wallet he can now interact directly with the SNX protocol through the SNX decentralized web application (also known as dapp). Owning his own tokens puts Bob in full control of his crypto assets; instead of a trusted third party such as a centralized exchange or bank.
Bob makes sure he has some ETH in his wallet too, because staking SNX requires interacting with the Ethereum blockchain; where each interaction involving value costs money in the form of ETH. New to Ethereum Bob was kind of surprised by these gas fees but he learned the situation has improved tremendously since July 2021; things are getting more optimistic.
Staying Optimistic
Using the SNX dapp Bob transfers his SNX to Optimism layer 2. To do this, Bob first autorizes the SNX smart contract to “spend” his SNX and secondly initiates the transfer action to layer 2. Bob is not very happy about the gas fees because he has to spend $100 worth of ETH for the transfer of his SNX to Optimism.
Transferring tokens (like SNX) between layer-1 (in our case Ethereum mainnet) and layer-2 (in our case Optimism) blockchains is expected to become much cheaper because of further integration of (centralized and decentralized) exchanges and layer-2 solutions.The answer to the question "when" is as always "soon".
After waiting a couple of minutes Bob is able to see his SNX amount on Optimism through the SNX dapp. It is now time for the final step to stake his 1000 SNX tokens…
Minting synthetic USD (sUSD)
Staking SNX is done by minting synthetic USD (sUSD). sUSD is the flagship stablecoin of Synthetix. As a true spartan Bob chooses “mint max” through the SNX dapp minting and receiving 1666,67 sUSD in his wallet given a collateralization-ratio (c-ratio) of 600%.
The c-ratio is a fixed percentage within the SNX protocol that determines the amount a staker his sUSD active debt (in our case the 1666,67 sUSD minted by Bob) is to be collateralized by staked SNX. The SNX protocol requires stakers to maintain their c-ratio (either by burning debt or increasing the amount of SNX staked) at the given minimum percentage at the penalty of liquidation if the c-ratio falls below 200%. At the time of writing of this article the c-ratio was 600%; however in the future the ratio will be lowered in steps to 400%.
By minting the 1666,67 sUSD the 1000SNX now have been staked and locked up within the SNX protocol; implemented by the SNX smart contracts that live on the Ethereum blockchain. Bob wonders about what he sees on-screen; especially wondering about the "active debt".
By minting sUSD, Bob not only acquired 1666,67 sUSD; he also at that point in time took upon himself the same amount in debt to the SNX system. The catch here is that Bob his active debt is going to vary over time and is not fixed, in contrast to the amount of sUSD he minted sitting in his wallet.
Why the variation of "active debt" ?
The debt pool
The debt pool is the total amount of debt pooled together underwritten by all SNX stakers combined. When Bob staked his SNX he may not have realized it; but in a way he basically became "the bank" enabling actual use-cases of the SNX protocol, such as:
- A Kwenta user who makes a large trade ($100K+) against the best execution price possible from sUSD into synthetic LINK (sLINK).
- A Lyra user buying a call option to leverage a long Ether position.
- A Thales user who wants to hedge a long position Bitcoin by buying short options for a Thales Bitcoin market.
The debt pool its composition in synths is impacted by the actual usage of the Synthetix protocol (as illustrated above; especially for the use case scenarios of Kwenta and Lyra). In addition, a synth its spot price at a given time depends on market conditions and may involve high volatility. The implication for our beloved Bob is that his part of the debt pool varies in size over time meaning his active debt may increase or decrease. Lets take a closer look what this means for Bob.
How Bob his debt can change
In this example Bob just staked his SNX as described earlier minting $1666,67 by staking $10,000 worth of SNX given a c-ratio of 600%. Bob decided not to do anything with his sUSD, however Bob is bullish about Bitcoin. What happens when the amount of debt increases?
Given the following debt pool composition on 14 October 2021:
And Bob his active debt is 1666,67 sUSD
When Bitcoin its market price suddenly increases from $60,000 to $70,000
Then the debt pool increases accordingly as shown below
And Bob his active debt increases too accordingly by 6,25% to $1770
In this example Bob is taken by surprise. His active debt just increased by 100 bucks, underperforming with regard to the debt pool. Because Bob decided to take a "set-and-forget" strategy not doing anything with his minted sUSD Bob effectively took a short position towards Bitcoin meaning if Bitcoin would have declined in value this would have been beneficial for Bob. However, the point here is Bob did not take the short position consciously being actually bullish about Bitcoin…
Managing debt and putting sUSD to work!
So what could Bob have done differently? In hindsight he should have managed his active debt by taking a hedged position versus the debt pool its composition. Bob didn't realise that the sUSD he minted should be put to work. The most popular and straightforward way to put your minted sUSD to work ("hedging your debt") is to mirror the debt pool; let's see how this works for Bob.
Given the following debt pool composition on 23 October 2021 on L2
When Bob is putting his minted sUSD in the amount of 1666,67 sUSD to work by mirroring the debt pool
Then Bob follows the below table "what Bob should do" with his minted sUSD
"What Bob should do" here is to buy the mentioned assets using his sUSD outside of Synthetix, for example using a exchange like Uniswap. While the system doesn't prevent Bob from acquiring synths themselves (eg. "swap sUSD for sETH through Kwenta" instead of real ETH) the principle here is that SNX stakers enable non-SNX stakers to execute use-case scenarios against the SNX protocol. More SNX stakers using freshly minted sUSD outside of Synthetix improves synth liquidity which itself is an important enabler for the usage of the SNX protocol by non-stakers.