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What are On-chain synthetic Assets?

Last Update: March 8th, 2022

A synthetic asset is a tokenized blockchain-based derivative of an underlying asset. Also referred to as synths, synthetic assets can be described as a combination of traditional derivative assets and cryptocurrencies. However, unlike the traditional financial world, synthetic assets add a record for a derivative on a blockchain, thereby creating a crypto token for it. Simply, synthetic assets are tokenized derivatives, with the growth in decentralized finance seen to fuel their growth in the crypto space.  

How Do Synthetic Assets Work?

Synthetic assets work similar to the traditional financial derivatives assets. The only difference between synths and traditional financial derivatives such as forwards, futures, and options is that traditional derivatives are backed by a contract while synths are backed by non-fungible tokens commonly referred to as NFTs in DeFi. Basically, the non-fungible tokens are smart contracts built on the blockchain technology. In trading, synths function in the same way as the traditional derivatives so that when the price or value of the underlying blockchain-based asset moves, the value of the synthetic asset moves. In simple terms, synthetic assets mirror the underlying blockchain assets in terms of pricing and value.

How Do You Make Synthetic Assets?

Synthetic assets are made through a process referred to as tokenization. Tokenization in blockchain technologies refers to the conversion of a meaningful piece of data into a random string of characters which has no traceable link to the original data. The process creates a new asset called a token. The token or digital certificate stands for the real-world asset and is issued to the investor as ownership rights. Powered by blockchain, the token cannot be breached to reveal original data. If breached, then data would be meaningless since the token only gives a reference to the data and not the data itself. Tokenization takes place in accordance with the synthetic asset protocol which can be both decentralized and distributed. Any asset can be the underlying asset for the token. The most popular in the recent past has been tokens whose underlying assets are digital art. This shows the extent of the financial revolution that comes with synthetic assets in DeFi.

What are the Advantages of Trading Synthetic Assets?

There are many advantages of trading synthetic assets including those that apply to traditional derivatives. The benefits include hedging risk of exposure, market efficiency, access to unavailable assets or markets, and price discovery or determination. With tokenized derivatives or synths, these advantages are extended. Synths create more liquidity than can be imagined under traditional derivatives with access to the global marketplace. Any person can issue synths or tokenized derivatives so long they follow synthetic asset protocol. There are tools like Synthetix, an open source protocol for the creation of synths. The ease of creating synths is behind the growing mentions of NFTs in the DeFi spaces. Above all, synths and tokenized derivatives enjoy frictionless movement in a borderless trading ecosystem powered by the concepts of DeFi and blockchain. DeFi eliminates the role of financial intermediaries that characteristically raise the transactions through duplicitous efforts especially when the trading is across borders. Trading synths in DeFi attracts almost insignificant cost and without any limitations of geographical borders. Besides, traders can enjoy anonymity which lacks in centralized exchanges for traditional finance. Transactions can still be traced in a distributed ledger making privacy a key step-up in synthetic assets trading.

What is Mirror Trading Using Synthetic Currencies? 

Mirror trading is a strategy which allows traders to copy the trades of experienced professionals. It is a strategy primarily used in the forex markets. In DeFi, the creation of synthetic assets creates an opportunity for novice traders to mirror the trades of professional traders. Mirror trading is made possible through the creation of synthetic currencies which mirror real currencies. Most importantly, mirror trading using synthetic currencies involves cryptocurrencies making it possible for traders to trade official currencies that are backed by economic and political stability through the trade of cryptocurrencies. With mirror trading, a novice trader can actually enjoy the same returns as the experienced professional trader while at the same time avoiding the high management fees that professional fund managers charge for their strategies. Mirror trading using synthetic currencies is another way through which DeFi levels the playing ground for the non-professional traders in the forex markets.

About the author

Eric Nkando // Financial Trader and Technical Analyst
Eric Nkando is a professional forex trader and financial analyst from Nairobi, Kenya. He has 3 years trading experience, with interests in Forex, cryptocurrencies, and commodities. He is a CPA(K) holder and a B.com degree (Finance) graduate. Eric’s market analysis and coverage have featured on leading financial websites including Wikifx and Seeking Alpha