Safely Unlock Synthetic Asset Era

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Author | Allison

If you (Alice) and your friend Bob make a bet that the outcome depends on the outcome of the event, then you have engaged in what is called a synthetic trade. If another friend of yours, Charlie, keeps the deposit to ensure that it can be cashed out after the game is over, then Charlie will act as your agent (escrow) and settlement layer (settlement layer). If you trust Charlie's rigor and fairness and let him judge, then he also acts as an oracle.

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Each synthetic product consists of the following core components:Synthetic products are popular precisely because of their flexibility

Before the advent of derivatives, commodity manufacturers could not hedge against falling prices of their products, and commodity consumers could not hedge against rising prices. There is also a $500+ trillion fiat interest rate derivatives market that allows borrowers to hedge their interest rate risk. Liquid interest rate markets make financial products such as 30-year fixed-rate mortgages in the United States possible. Otherwise, no bank would lend out a 30-year fixed-rate loan if bank debt tended to offer a liquid rate.

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Why are on-chain synthetic assets so important?By tokenizing real assets through a centralized medium, valuable financial products will share the same clearing layer. However, opening financial markets does not remove all barriers to entry, as users ultimately must trust a centralized intermediary or custodian and abide by its rules. Synthetic products on the blockchain promote the fairness and openness of the market by removing various barriers to entry in all financial markets, allowing any individual, entity or decentralized autonomous organization (DAO) to use any type of financial product, while , and can also avoid centralization or single points of failure.

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DeFi synthetic assets

Dai, a stablecoin managed by MakerDAO, is one such synthetic asset.

• It is called a synthetic asset because it has two main characteristics:

• The price of Dai is pegged to the U.S. dollar (USD);

The value of Dai is backed by the value of the collateral, not inherent in itself.

• The price of Dai is backed by ETH and pegged to the U.S. dollar (USD). However, other target prices can also be anchored on the Maker platform to obtain various synthetic assets:

• Anchoring Gold/ETH, you can get gold (Gold) synthetic tokens, endorsed by ETH

• Anchoring EUR/ETH, you can get euro synthetic tokens, endorsed by ETH

This ingenious financial design is like a kaleidoscope, giving "financial engineers" full autonomy and creativity. We can exchange any staked token for any synthetic token. It is even possible to mortgage synthetic token A and exchange synthetic token B.

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(Above) Synthetic assets can be designed to enable a wide variety of applications—both for synthetic token holders and issuers. The above figure only gives the most superficial description.

• That said, not all synthetic assets have the same price. For different purposes, users need to carefully consider the characteristics of a synthetic token. It's really not that hard, just ask yourself these two questions:

• Under what conditions can I rely on the value of the pegged synthetic token?

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Comparative evaluation of DAI and sUSD

In order to explain clearly, it may be necessary to evaluate Dai and sUSD in comparison. Both have a target price of $1, however their liquidity guarantees and mechanisms for maintaining the peg are quite different.sUSD is more suitable for short-term speculation.

sUSD trades at exactly $1, but is only available on the Synthetix exchange. As long as the oracle price is accurate and the collateral in the fund pool is sufficient, all transactions on the Synthetix exchange can be carried out at a reasonable price. This feature makes sUSD more speculative than other synthetic assets on the Synthetix platform. However, without this platform, sUSD lacks immediate tools to maintain its stability.Dai is more suitable for long-term holding.

The trading price of Dai fluctuates around $1, yet because of this, the MakerDAO governance system employs many means to balance supply and demand. In a worst-case scenario though, a Global Settlement could result in all Dai being redeemed against $1 collateral. Of course, Dai will maintain its value as long as MKR holders work together to create a proper governance scheme. This characteristic of Dai makes it unsuitable as a short-term trading alternative currency for USD, but it is very beneficial for long-term stable value storage (provided you trust MKR and the MakerDAO Foundation).

As users, we have to know what we need as an endorsement and how long to hold it. Do we need a short-term liquid asset or a long-term store of value? These questions can help you choose the right synthetic asset protocol.

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The oracle problem

No matter which asset protocol is used, they will use oracles to some extent.

At present, the biggest problem facing the DeFi circle is the oracle machine. Some recent events were clearly caused by oracle problems: the bZx flash loan attack, SNX oracle front-running, and the Maker Black Thursday incident.

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Solution 1: Need to use off-chain pricesProvable Things, Chainlink, and even Compound’s open-source oracles extend this solution. In order to improve its security, many DeFi contracts also delay before the price on the chain is available, or add "circuit-breakers", that is, the maximum value of the price within a specific period of time. We need to make trade-offs for such strategies, such as the possibility of leading to oracle front-running or more severe operational uncertainty.

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Solution 2: Without resorting to off-chain pricesfirst level title

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