Synthetix: the Most Progressive Experiment on the Synthetic Token and the Protocol Economy
Since 2017, Hashed has invested actively in the DeFi industry. We started out our DeFi journey by investing in Kyber Network at the early stage, and expanded our footprints by investing in Maker’s MKR token. In line with these efforts, Hashed has helped Synthetix team to expand its business since early 2020. We believe that Synthetix is one of the key players in the DeFi ecosystem for its TVL(Total Value Locked) is approximately $321M — the third biggest DeFi protocol following Maker. But, it is not just the size of Synthetix but the team’s vision on DeFi that led Hashed to take a deeper look. Indeed, Synthetix is the team that by far has come closest to Hashed’s DeFi theses.
Ethereum smart contracts are powering the DeFi industry, and DeFi protocols are showing the most rapid growth among all dApps. Hashed has faith in the potential of the DeFi industry. Indeed, we have worked to contribute to and power the DeFi ecosystem for a long time.
Synthetic Tokens: the Biggest Milestone for DeFi
DeFi is evolving in a phased manner. Assets that DeFi covers have expanded from cryptocurrencies such as ETH to network tokens (BAT), synthetic stablecoins (DAI), fiat-backed stablecoins(USDT, USDC), and tokenized real estate(RealToken). Eventually, synthetic tokens will become the most significant milestone for the whole DeFi industry.
Those who are familiar with DAI can easily understand how the synthetic token system works. For instance, in Synthetix, its main Synthetix Network Token (SNX) is locked up to create synthetic assets such as synthetic USD (sUSD) — SNX acts as the collateral while sUSD acts as debt. Synthetic tokens are similar to the traditional synthetic assets as both allow people to bet on the price of an asset without holding the actual asset. However, synthetic tokens utilize collateral and liquidation to synthesize targeted yield curves while the traditional synthetic assets have to hold various financial products to do so.
The evolution of how assets are managed and traded in the DeFi ecosystem could go in vain if the managed assets are not big enough. Currently, ETH and stablecoins are the main assets, yet we cannot just wait in a passive manner for these asset market caps to grow. We believe the DeFi ecosystem will grow further along with the growth of virtual reality layer. For instance, blockchain games will give birth to various assets that act as currency or (virtual) real estate, and will present more opportunities for DeFi services. But, this seems to be quite a distant future. Therefore, it is a more realistic approach for DeFi services to target existing real economy assets as their short- to mid-term objectives.
One of the simplest methods to bring the real economy asset transaction volume to a blockchain is to put those assets to the off-chain custodian and launch tokens. This method is similarly adopted by USDT or USDC which are backed by dollars in banks. Indeed, many are experimenting this idea with tokenized real estate so that they could implement tokenization to other assets. However, the tokenization requires centralized intermediaries or administrators who will carry out fiduciary obligations. Moreover, there is a room for legal conflicts whether those tokens could represent ownerships. For instance, if real estate tokens are hacked, would hackers have ownership over the underlying assets (real estate in this case)? By leveraging synthetic tokens, we can minimize the role of custodian and come up with more innovative approaches.
Yet, the synthetic token system has its own tradeoffs. Inevitably, there is a discrepancy between the tokenized synthetic options and regular options. Even if the tokens are backed by the same asset, there are many other factors that need to be taken into account: collateral type, a ratio of collateral and debt, maturity and so on. This leads to low fungibility of synthetic tokens. Moreover, if the market begins to move along or against futures position, one may question whether the synthetic option could move at the same speed to reflect either the profit or loss. Let’s say a company pays out dividends or proceeds to merger or gives stock warrants to incumbent stakeholders. In this scenario, the biggest concern for the token holders would be whether the token price reflects the company’s aforementioned actions. If not, the token price discrepancy will happen. Another issue that could be raised has to do with credible price information. If the price information of collateralized asset or backing asset is not accurate, there are higher chances of system participants encountering unexpected losses or malevolent actions by system attackers. This is why Synthetix has partnered with Chainlink’s decentralized network of oracles to provide reliable price feeds.
Liquidity Maximization: How Synthetix Approaches Synthetic Token
There are numerous ways to create synthetic tokens. On Synthetix, the tokens are perpetual contracts with no expiration date. This allows much more flexibility — indeed it maximizes the possibility of token swaps. However, Synthetix has a shortfall as one cannot easily define the nature of the purchased token. Synthetic tokens with expiration dates are very similar to traditional finance future contracts except for the liquidation part. And, for these tokens to allow liquidating the collateralized assets at the expiration date, synthetic tokens can find the price naturally. On the other hand, synthetic tokens with no expiration date are similar to the perpetual future contracts that one can find from Bitmex or Binance. These synthetic tokens without expiration dates require special instruments to somehow mimic the liquidation process. And, due to the uniqueness of synthetic assets, long/short position liquidity could potentially become a problem.
Synthetix sets itself apart from any other crypto derivative platforms for it uses smart contract as its counterparty. This unique approach offers users advantages like easy price match with asset and infinite shared liquidity. Since liquidity is pooled by aggregating all collateral together, every platform participant shares counterparty risk together. And, this makes the system relatively more vulnerable to oracle attack targeting price feed. Synthetix team acknowledges these shortcomings and is working on the solutions. For instance, one could think of instruments like “Funding Fee” from Bitmex as a means to mitigate the aforementioned risks. Synthetix recently launched a beta version of binary options as a new trading feature. And, it is planning to launch more functions such as futures trade. Regarding the potential oracle attack, the team has made a partnership with Chainlink to provide more credible price information for users.
How Synthetix Expands: Form Community through the Protocol Economy
Hashed has constantly argued the significance of the protocol economy from very early on. The protocol economy is an economic system where individuals or groups can participate in the economic activities and earn rewards according to their contributions. This model is similar to that of the Bitcoin mining network. In this economic model, community is the key component. And, in order to run this community seamlessly, an overarching yet sustainable token model is needed that could encourage benevolent actions and curb malevolent actions.
We believe that Synthetix is a team that is vigorously testing the protocol economy concept with its SNX token reward model. The participants of Synthetix platform are being rewarded with SNX, and liquidity providers of Synthetix to liquidity pools such as Uniswap or Balancer are getting SNX rewards. This model, if executed in a right manner, could encourage the network participants to eventually become stakeholders who pursue long-term network incentives. With the introduction of the protocol economy, Synthetix network participants are rapidly increasing. Along with this growth, the token price of SNX also increased significantly. Other projects are joining the wave of the protocol economy too. For instance, Kyber Network with the latest Katalyst update attempts to reward token holders who are participating in the Kyber governance. Compound, one of the most promising crypto lending services, is also rewarding its network token COMP to network participants. We believe that the protocol economy model that Synthetix team adopted has provided a good precedent for other crypto projects.
Synthetix is indeed the project that is experimenting with the most progressive idea on the synthetic token and the protocol economy. And, Hashed supports this team fully to succeed. At the Hashed Seoul office, there are numerous resident blockchain projects including MakerDAO Korea. And, Synthetix will move to Hashed space as it is planning to open its Korea office. Although DeFi is somewhat underactive in Asia, the Western blockchain community is embracing and experimenting this concept. As a blockchain investor that has offices both in Asia and the US, Hashed is going to expand its footprints among the DeFi projects worldwide. Indeed, we will not stop ourselves from just throwing money into the projects with high potential, but actively help those DeFi teams in areas like brand awareness and user acquisition.
