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Synthetic Crypto vs. Traditional Synthetic Assets: Key Differences Explained

2021-11-01 10:34:21

Despite their apparent antagonism, several aspects of traditional finance have successfully migrated to the burgeoning cryptoverse. For instance, functionalities like trading, lending, and borrowing operate smoothly on blockchain-cryptocurrency platforms. Synthetic crypto is the latest addition to this list.


What are Synthetic Cryptos?

In general, synthetic assets refer to derivatives that “derive” their value from an underlying asset like stocks, bonds, commodities, or currencies. Presently, the global derivatives market, which is worth $15.8 trillion, is steadily shifting base towards the blockchain-cryptocurrency sector. In the cryptoverse, a synthetic coin refers to tokenized derivatives that are executed and stored immutably on the blockchain. Thus, a synthetic token is essentially a blockchain-powered representation of derivatives.

How Do Synthetic Tokens Work?

Several crypto-based derivatives platforms, both centralized and decentralized, facilitate the issuance, trading, and other services for synthetic assets. By these means, synthetic crypto has opened up new avenues for different kinds of investors. Therefore, synthetic trading is a way of generating value from derivatives transactions. Moreover, synthetic futures trading is a form of crypto-based futures contract trading, and is quite famous among investors. Trading in synthetic crypto is a foolproof way of hedging against market risks and volatility.

There are several synthetic tokens, but the most famous one is perhaps the Synthetix token (SNX), which has a market cap of $1.3 billion.

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Synthetic Crypto vs. Traditional Synthetic Assets: A Comparative Analysis

Blockchain Technology

Blockchain makes synthetic crypto safe, secure, transparent, and traceable. Since all transactions are immutably recorded on a public ledger, they remain verifiable and accessible to scrutiny. Digitized derivatives are cataloged online and investors are issued tokens to certify their ownership.

The blockchain-based synthetic token has multiple advantages. First, ownership rights are undisputed as they are stored on the blockchain securely and permanently. Second, it’s possible to issue a fractional synthetic coin to investors. Consequently, fractional ownership of real-world assets like real estate, gold, and other precious metals. As a whole, the industry benefits from unprecedented investment opportunities.

Decentralized Setup

Synthetic assets have grown enormously with the rise of decentralized finance (DeFi). Synthetic crypto has automatically inherited some of DeFi’s characteristics. To begin with, DeFi functions without banks, brokerages, or any other centralized regulatory financial institutions. DeFi eliminates opaque processes by using blockchain technology. Not only that, but DeFi also reduces processing time and approval red tape by doing away with all sorts of bureaucracy. Investors are thus self-sovereigns, seamlessly accessing and transacting in synthetic cryptocurrency. Automatically, this translates into more liquidity for all types of synthetic crypto.

Smart Contract Functionality

The other thing that makes synthetic tokens stand out from traditional synthetic assets is smart contracts. These self-executable and automated algorithms make synthetic crypto transactions more robust and secure. Smart contracts execute transactions only when they fulfill certain predefined conditions and rule out any possibilities of dishonestly manipulating synthetic asset transactions.

Smart contracts have also made possible a borderless world of finance. Additionally, synthetic crypto offers the opportunity for passive income and extra rewards through staking or vesting. Investors can earn more with synthetic cryptocurrency than through traditional synthetic assets.

What are the downsides to Synthetic Crypto?

Despite synthetic crypto being superior to traditional synthetic assets, they have certain limitations.

First, any software is prone to bugs and hackers. Malicious and ill-intentioned hackers can exploit vulnerabilities in smart contracts and siphon off funds from synthetic assets.

Second, since the synthetic token derives its price from underlying real-world assets, it is heavily reliant on oracles. These oracles feed real-time price data into the synthetic coin. However, since oracles gather these data from third-party sources, the integrity of the information sometimes gets compromised.

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Third, the underlying blockchain on which a synthetic cryptocurrency functions might falter due to scalability issues. The transaction fees might also be quite steep due to network congestion. Ethereum mostly suffers from these issues but they will soon be rectified with Ethereum 2.0.

The Role of Synthetic Cryptos in DeFi’s Growth

In spite of its drawbacks, synthetic crypto has in fact revolutionized the financial world. The synthetic token is way easier to access and trade than traditional synthetic assets. Additionally, digitally tokenizing derivatives have made the market more democratic than it was previously. With blockchain’s security and robust smart contracts, synthetic crypto is geared towards a roaring success.

Thus, the digital asset management firm, Arrington XRP Capital, has said synthetic assets “are one of DeFi’s…Trojan Horse into legacy markets.” Synthetic crypto indeed has the potential to dismantle traditional financial systems once and for all. However, given that an elaborate regulatory framework governs the traditional synthetic market, the synthetic cryptocurrency domain has nothing yet. Although there is a rising clamour for regulating synthetic assets, many believe that regulation will be counterintuitive.

Only time will tell how synthetic crypto positions itself in the market. But for now, the synthetic token is all set for a path towards innovation and mass adoption.

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