Synthereum: synthetic assets to bring traditional assets on Ethereum

Since 2017, our narrative has always been an utopian Internet of Finance and its browser that would make all investment opportunities as accessible as a web page is and would break down the borders between assets — the famous interoperability.

Technology has allowed this utopian vision to slip to reality: decentralized finance weaves a network of passive and active investment opportunities that wallets mimicking browsers hasten to aggregate, and synthetic assets make it possible to see interoperability between all asset classes.

In this article, we present the vision and functioning of Synthereum, our protocol for issuing synthetic assets.

TL;DR: leveraging from UMA, Chainlink and Compound, Synthereum allows to issue synthetic assets tracking the price of any traditional asset, and instantly convert between them through a burn and mint mechanism. The collateral in cDAI is provided by a liquidity pool matching user’s deposit; the user only needs to deposit the exact value of the assets, and the pool is responsible for over-collateralizing the contract and maintaining the collateral ratio.

Vision

Any sufficiently advanced technology is indistinguishable from magic. Arthur C. Clarke

Synthetic assets make it possible to elegantly link traditional finance to decentralized one and make the latter more accessible and powerful than ever.

They allow everyone to convert their local currency into its synthetic version on the Blockchain — a prowess that will be free of charge and of KYC, and in most cases instant, in the Jarvis wallet.

They remove the boundaries between assets, make them fully programmable and redefine the very concept of money! An Apple stock could be converted to Bitcoin or oil, could be used to pay a restaurant bill in euros, or as a deposit to trade Forex.

Together, these properties will allow Jarvis applications to provide its users with fiat-based applications using their local currency. Even sexier, they will allow to combine several asset classes into diversified portfolios and manage them in the most flexible way. These assets coupled with natively integrated protocols such as Compound are the last piece of the puzzle for dreaming of Revolut from DeFi.

Under the hood

Synthereum uses UMA for the issuance of these synthetic acts.

UMA is a decentralized financial contracts platform built to enable Universal Market Access. Use UMA’s self-enforcing contract design patterns and provably honest oracle mechanism to create your own financial products using standards like ERC20.

Synthetic assets 101

While tokenization is a relatively simple concept, synthetization requires a little more concentration.

Behind each USDC stands a real US Dollar in a bank account, and 1 real dollar could be redeemed for 1 USDC; hence users can trust the value of USDC. Behind each DAI there is at least 1.5 dollar worth of Ether in a smart contract, and 1 Dai could be redeemed for the Ether backing it; it is the confidence in the value of Ether that allows user to trust the value of the DAI; in this case, we say that Ether collateralizes Dai with a collateral ratio of at least 150%.

As long as the value of the Ethers in collateral behind each Dai worth more than a dollar, the Dai is sufficiently collateralised and users can trust that it worth a dollar. Since it is not possible for a smart contract to know the price of Ether and therefore the value of the collateral, an oracle is needed to upload it on the Blockchain and update it regularly, by sending transactions containing this information. Once the transaction is validated, the price of Ether is updated on the Blockchain and the smart contract can access it, and thus know if Dai is sufficiently collateralised. For a synthetic asset tracking the price of a share, in addition to the price of the collateral, the oracle should also update its price to check whether the synthetic asset is enough collateralised.

Since the price is updated only through transactions, it is not possible to have a real-time price; at best we could update the price of an asset at each block (every 13 seconds on Ethereum) but it comes at a huge cost that no-one is ready to pay; thus most oracles update prices only every x minutes or x hours; the technology will evolve for sure and some oracle projects like Chainlink are working on providing such solutions.

jToken issuance

From the user’s point of view, it appears as a classic exchange: assuming a EURUSD at 1,100, he would send 1,100 Dai to receive 1,000 jEUR. However, no exchange took place…

Their 1,100 Dai are deposited in a smart contract where 200 Dai from a liquidity provider (LP) await them, forming collateral of 1,300 Dai; the latter is supplied on Compound and the interest generated is redistributed to the stakeholders through the use of rDAI; in fact, it is the latter that effectively collateralizes the synthetic euro with a 118% collateral ratio (a whimsical number for the sake of the example).

The use of LPs greatly optimizes capital and liquidity: neither the end-user nor the LP has to mobilize a surplus of capital to over-collateralize the asset they wish to issue or sell. As a reminder, Dai (Maker) is a synthetic asset which requires at least a collateral ratio of 150% collateral ratio, and the sUSD (Synthetix) requires 750%.

You can create your first synthetic EUR, CHF, GBP or XAU on the Kovan testnet (you will need kDAI and kETH for this).

• test the demo (you need Metamask put to Kovan)
• jEUR on etherscan

jToken conversion

It will obviously be possible to exchange jTokens between them via pools like Uniswap or using some Dex, but you will suffer from a slippage that increases with the size of the transaction. Therefore, it will be more interesting to issue a new asset rather than buying it or to convert them through a burn and mint mechanism rather than to exchange them.

The burn and mint mechanism is an elegant way to convert synthetic assets without the need for a counterpart: instead of making an exchange between a buyer and a seller, the asset sold is burnt at the same time as the asset purchased is minted. To take the example of the 1,000 jEUR collateralised by 1,300 Dai, they would be burnt and replaced by jGBP of the same value, using the same collateral. There is no spread, no slippage, and theoretically infinite liquidity.

jEURs can be instantly converted to jAAPL, which in turn can be converted to jGLD (gold). The number of possible pairs is therefore unlimited.

Due to the volatility of certain assets, their synthetic version might require more collateral than another, and vice versa; in this case, the liquidity providers idled funds in the pool will be used to satisfy the minimum collateral ratio.

Role of the LP

The first version of the protocol, named Bled (after a beautiful city on a lake in Slovenia) allows only one LP maintained by us, but in future releases, everyone will be allowed to participate.

The LP main role is to provide counterpart and over-collateralisation of synthetic assets.

For illustration, let’s take our 1,000 jEUR collateralised by 1,300 Dai…

• If EURUSD rises to 1,200 and the user decides to convert them back to Dai, they will redeem 1,200 Dai, taking 100 Dai from the LP funds. Conversely, in the event of an equivalent fall, they would only have recovered 1,000.
• If EURUSD rises to 1.3000, the 1'000 jEUR would worth 1'300 Dai and would be under-collateralised — since the collateralisation ratio should be at least 102% for euro, ie 1'326 Dai — and would be liquidated; in which case the commissions and interest generated until then by the LP will be confiscated and returned to the liquidator; to avoid this situation, the LP must add collateral as the price of the tracked asset goes up.

The LP thus bears all the risks, in exchange for which it will receive a commission of 0.1% on each token minted, and the entire interest generated by the collateral (so they would earn interest on their deposit and on the user’s).

These parameters can be modified by the DAO once it is in place.

Since there is no slippage or spread, users will tend to issue new jEURs rather than buying them on exchanges, thus generating more interest and commissions for LPs.

Eventually, since the LP is the counterpart, it has a short exposure which will cost it if the EURUSD rate goes up. To mitigate this risk, savvy LP could open a long position on EURUSD using Jarvis exchange, powered by our Margin protocol, and cover the funding fees with the Compound’s interests collected.

Oracle

Synthereum leverages from Chainlink trustless price feed.

Chainlink is a decentralized oracle network that enables smart contracts to securely access off-chain data feeds, web APIs, and traditional bank payments. It is well known for providing highly secure and reliable oracles to large enterprises (Google and Oracle) and leading smart contract development teams such as Polkadot/Substrate, Synthetix, Loopring, Aave, OpenLaw, Conflux, and many others.

Chainlink was a natural choice for Jarvis Network as they are the market-leading oracle service provider, whose price feeds are powering a growing ecosystem of DeFi applications.

However, the next release of Sythereum will minimize the usage of the oracle: although Chainlink’s solution is excellent, the design of our protocol makes it vulnerable to front-running attack, regardless of which oracle solution it uses.

The Chainlink oracle updates the EURUSD price every time it moves from +/-1%. Therefore, an attacker could wait for EURUSD to go 1% which will trigger a transaction from Chainlink; they would monitor the oracle’s pending transaction and once they spot one, knowing that after this transaction will be confirmed the price of EURUSD will go 1% up, they could mint jEUR at the current price by submitting a faster transaction; as their transaction will be confirmed before the oracle’s, they would issue jEUR just before the price changes and then to redeem Dai right after that, cashing in a gain of 1% at the expense of the LP.

Few solutions exist to prevent this type of attack. One could be to forbid the minting of synthetic assets when Chainlink submits a transaction, but this implies the use of a centralized solution. Another one requires no centralized intervention: inspired by the Synthetix’s fee reclamation solution, this would involve adding a commission of 1% in the event that a user converts their freshly minted jEUR back into Dai, or transfers them to another address before a new price update arises. This fee will make front-running not profitable.

However, these solutions would cost more money to develop and implement than what the front-running exploit will, considering that we will keep the liquidity pool quite small on the mainnet until we have done security audit, and since the next release will resolve these issues in an elegant manner:

“The best oracle is the one you use the least” insists Allison Lu, founder of UMA.

Oracles are indeed the most sensitive elements of a decentralized system and the main vector of attack; for this reason, the medium-term goal is to adopt the UMA’s priceless framework: there is no need for an oracle as long as everyone agrees on the price; they are only needed when a dispute arises.

More details will be given at the launch of Opatijia, the next release of Synthereum.

All our releases will bear the name of a fantastic city bordered with water.

Risks

Since Synthereum combines several protocols, it also combines all their associated risks.

The collateral used to synthesize the assets is Dai. Dai itself is an experimental synthetic asset collateralised by Ether; during the last crash caused by the Covid-19 crisis, Maker’s oracles misbehaved and for several hours some Dai were not collateralised; a bit later, another issue arose and almost 6M of Dai were no longer collateralised by any Ether. Maker is currently fixing these issues in ways that they might not happen again, but others may occur.

The collateral in Dai is supplied on Compound; although the loans are over-collateralised, that the protocol behaved very well during the last crash, that numerous audits were carried out and that the team behind is very serious, there is no such thing as zero risks, and providing liquidity on Compound involves risks; risks to which are added to those carried by rDAI, a small protocol which is used on the top of Compound to split and redirect the interests across different addresses; yet, rDAI contracts have been audited by Quantstamp, one of the most prestigious security firm.

And of course, there is a risk on the smart contracts of Synthereum and UMA. The latter is administered by a DAO whose token holders can vote to make changes to the code; the voting process takes 2 to 4 days and the effects are immediate.

Conclusions

If today technology does not yet allow Synthereum to facilitate the creation of applications capable of competing with Robinhood or Revolut, its evolution will undoubtedly allow it in a year or two maximum. By then, the oracles and scalability solutions will need to be improved.

Although Synthereum started as a secondary project to answer a simple UX issue — being able to trade with an account denominated in euro on the Jarvis exchange — it received a lot of attention and took more and more space in the Jarvis network, to the point of becoming its cornerstone. We hope it will be as valuable to us as it is to the DeFi ecosystem and, thanks to its composability, will be integrated into several applications and protocols.

We are already dreaming of Set Protocol combined with 3box and Synthereum to create a permissionless Etoro; a Monolith card that would allow you to spend your jGBP or jAPPL; a Curve pool which would provide jEUR/USDT pools and finally a Paraswap which would allow swapping any ERC20 token for any jTokens, and whose API or SDK would be used by many wallets, spreading our assets everywhere.

Pascal.

The possibilities are limitless
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