What is Synthetix (SNX)?

Introduction

Synthetix initially started as a stablecoin project called "Havven," but underwent a significant transformation during the downturn of the cryptocurrency market, evolving into a synthetic asset protocol. The community behind Synthetix has pioneered various mechanisms, making it one of the important standards in the DeFi space today.

As a core component of Ethereum DeFi, Synthetix is set to launch a Layer 2 scaling solution. In the future, Synthetix will continue to play a vital role in the DeFi landscape.

What is Synthetix?

Synthetix is a synthetic asset protocol that allows users to issue synthetic assets on the Ethereum network. Synthetic assets can be viewed as a type of derivative that provides a way to gain market exposure without having to own the underlying assets.

What types of synthetic assets (or "Synths") are included? In fact, they cover nearly all assets with reliable price sources, such as cryptocurrencies like Bitcoin and Ethereum, commodities like gold and silver, and fiat currencies like the U.S. dollar. There are even inverse synthetic assets (inverse Synths) that facilitate short selling or hedging current holdings and liquidity mining positions.

The core idea is that, by using Synthetix, traders can access certain assets that do not exist on-chain. Additionally, Synthetix supports the creation of various indices, such as a DeFi index that tracks a portfolio of DeFi assets.

How Does Synthetix Work?

Synthetic assets utilize decentralized price oracles to track the prices of underlying assets. It is important to note that Synths are different from cryptocurrencies backed by reserves, such as stablecoins. Unlike traditional reserves, the value of Synths derives from a complex array of on-chain mechanisms and smart contracts.

For example, BUSD is a stablecoin where each BUSD is backed by one dollar in reserves. Similarly, Paxos' "PAX Gold" (PAXG) is supported by physical gold bars. In a sense, holding PAXG is equivalent to holding a reserve of gold; in other words, PAXG is a token that represents ownership of gold.

In contrast, Synths track asset prices through intricate smart contract mechanisms. Holding sXAU does not mean you own any physical gold; it merely grants you the right to gain exposure to gold prices.

So, what is the significance of holding these assets? As mentioned earlier, they provide a convenient way to gain price exposure without actually owning the underlying assets. Another major advantage of Synths is that they are ERC-20 tokens on Ethereum, making them easy to integrate with other DeFi protocols. Users can deposit Synths into platforms like Uniswap, Sushi, or Curve, providing liquidity and earning trading fees just like with other ERC-20 tokens.

Synthetix Network Token (SNX)

Since synthetic assets do not have underlying assets for backing, what are these tokens collateralized by? Primarily, they are backed by the platform’s own token—SNX. Recently, Synthetix has also introduced Ether as an additional collateral option.

Synthetix employs an over-collateralization model, meaning that the collateral value for all synthetic assets exceeds their actual value. Users create Synths by staking SNX and minting synthetic assets. In other words, Synths essentially represent a debt based on collateral.

Debt positions must maintain a certain collateralization ratio, which is determined by governance mechanisms. This ensures that Synths have sufficient collateral to eliminate deficits within the system, helping it to operate stably during extreme market fluctuations. Stakers can manage this ratio by minting and burning Synths (debt) or by adding more collateral to continue earning staking rewards.

Infinite Liquidity and Zero Slippage

Synthetix does not utilize a traditional order book or slippage; instead, it positions itself as a trading platform that provides "infinite liquidity." Its pricing mechanism is algorithmically determined, resembling the workings of an automated market maker (AMM) rather than a centralized limit order book (CLOB).

In Synthetix, the trading counterpart is not an individual or market maker. Traders are required to repay a portion of the debt in the debt pool while borrowing an equivalent debt from another Synth.

This mechanism is relatively complex and involves many nuances. However, it is important to understand that trading in Synthetix differs fundamentally from trading on the Binance order book or within Uniswap liquidity pools.

Synthetix and Optimism

So, why hasn’t Nasdaq completely migrated to the Synthetix trading platform? In reality, the fees and execution methods of the Ethereum mainnet are not suitable for most traders and trading styles. Therefore, Synthetix contracts have chosen to deploy on a Layer 2 solution called Optimistic Rollup, developed by Optimism.

Rollups are an excellent method for scaling blockchains. They obtain security from the Ethereum blockchain, contrasting sharply with other scaling solutions like sidechains, which rely on a unique set of validators for self-security. This is a key distinction. Rollups can achieve the same scaling advantages as sidechains, such as increased transaction throughput and reduced fees, without significantly compromising security.

However, Synthetix's smart contracts are relatively complex, making it challenging to migrate them securely to such advanced technology.

Conclusion

Synthetix is a synthetic asset protocol on Ethereum. Synths can track the prices of underlying assets without users needing to actually own those assets. As one of the earliest DeFi projects, Synthetix has established a decentralized governance structure through SynthetixDAO. Although its principles may be complex, the gradual deployment of Synthetix on the Optimism rollup solution is expected to enhance its adoption.

Risk Warning

While the cryptocurrency market offers significant growth potential and innovation opportunities, it also carries a high level of market risk and price volatility. The value of crypto assets can fluctuate dramatically in a short period, potentially leading to substantial financial losses for investors. Additionally, the cryptocurrency market faces multiple risk factors, including technical risks, legal and regulatory uncertainties, cybersecurity threats, and market manipulation. We strongly advise users to conduct thorough research and due diligence before making any investment decisions and to consult professional financial advisors. All investment decisions are made at the user’s own risk. Thank you for your trust and support of Venkate!

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