What are Cryptocurrency Synthetic Assets and Why Are They Important?

The term ‘synthetic asset’ relates to a combination of assets with the same value as another asset. Typically, synthetics combine different derivative products, such as options, swaps, or futures, that simulate an underlying asset like stocks, bonds, indexes, commodities, currencies, or interest rates.​

For instance, instead of buying a stock, an investment company may purchase a call option and sell a put option on the same stock. The use of synthetic​ assets here enables the company to use multiple financial means rather than a single investment asset.

Derivatives can be utilized to help eliminate the price risk from a number of assets like commodities to debt. However, derivatives can also promote and exacerbate market ineffectiveness, supporting a zero-sum game among traders instead of creating actual market value. The use of derivative products enables investors to earn returns without a physical settlement, transfer risk, arbitrage trade, and hedge against price fluctuations.

What are Crypto Synthetic Assets?

Cryptocurrency-based synthetic​ assets want to give users exposure to a number of various assets without having to hold the underlying asset. This could be fiat currencies, commodities, or other digital assets.

​By utilizing these exceptional synthetic​ assets, investors can still hold tokens that monitor some assets’ value without having to leave the cryptocurrency ecosystem. Crypto synthetic assets also provide users with all the benefits of decentralization, as they are open to all users worldwide by using secured smart contracts and other tools, and the data is stored on distributed ledgers.

For instance, Abra is a decentralized investment platform that enables users to use their cryptocurrency as collateral to create synthetic​ assets. Abra’s synthetic​ asset model leverages smart contracts allowed with Bitcoin (BTC) and Litecoin (LTC).

Synthetix is another platform based on Ethereum that allows users to mint and trade synthetic​ cryptocurrency on its peer-to-peer platform. This makes it possible for users to access synthetic​ products that concurrently give them exposure to non-crypto assets like gold, stocks, and USD.

The Synthetix developer team has created a multi-layer issuance platform, an exchange, and a kind of collateral, which made a market for cryptocurrency-backed synthetic​ assets. Synthetix enables users to issue numerous synthetic​ assets, such as fiat, cryptocurrencies, derivatives, and various asset classes – for instance, Bitcoin, euro, USD, gold, Tesla stocks, etc.

The user puts collateral in the form of SNX tokens to create these synthetic​ assets. The user then would be able to trade or exchange one synthetic​ asset for another, repricing the collateral via an oracle without a middleman.

Another example is Universal Market Access, which is a decentralized platform for financial contracts that uses a ‘provably honest oracle mechanism’ and smart contracts to encourage users to create their own financial products.

Basically, UMA users can create financial products, using protocols like ERC-20 to develop tokenized derivatives that allow them exposure to basic real-world assets similar to the way traditional exchange-traded funds operate.

The Bottom Line

So why are cryptocurrency synthetic​ assets such a big deal? Crypto-collateralized synthetic​ currency models powered by smart contracts can have massive implications in the classical finance sector. In their essence, these models provide cryptocurrency holders the leverage to trade traditional assets and also derivatives while staying in the digital ecosystem.

Decentralization offers open-access to a global community of investors. Before products like Abra, Synthetix, and UMA became available, only a few institutional investors could have access to the global derivatives market. Now, anyone with a mobile phone and an intermediate that understands the basics of the synthetic​ asset underworkings can access these robust investment means.

With cryptocurrency synthetic​ asset platforms creating possibilities to derivatives for numerous new investors, only time will tell what kind of effect a potential flood of new cryptocurrency-collateralized derivative contracts will have on the traditional financial industry.

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