Synthetic assets are tokenized financial instruments based on a blockchain. They are a digital reflection and a certain derivative of the underlying asset. These financial instruments in the cryptocurrency community are often also called synths. This specific type of synthetic asset is most often described as a combination of traditional derivatives and digital currencies. However, unlike the traditional financial sector, synthetic assets add a record for a derivative to a distributed ledger, thus creating a crypto token for it. To illustrate it even more simply, synthetic assets are a type of tokenized derivatives, and the exponential growth of the DeFi ecosystem is seen as a driving force for the growth and development of this new variant of digital financial instruments.
How do synthetic assets work?
The mechanism of operation of synthetic assets is surprisingly similar to traditional derivatives as we know them from classical economics. The only difference between synths and traditional derivatives such as forwards, futures and options is that traditional derivatives are backed by contract, while synths are backed by native tokens created by individual DeFi protocols. Essentially, native tokens are smart contracts designed on top of blockchain technology. In the trading process, synths work in a very similar way to traditional derivatives. It follows that when the value of the underlying blockchain-based asset changes, so does the value of the synthetic asset. Put simply, the primary job of synthetic assets is to mirror the underlying asset on the blockchain in terms of price and value.
How to create synthetic assets?
Synthetic assets are generated in a process called tokenization. Tokenization based on blockchain technology consists in converting a significant piece of data into a random string of characters that, in principle, has no identifiable link to the original data. The result of this process is the creation of a new digital asset called a token. A token or digital certificate is a type of real asset and is issued to the investor as some form of ownership. The token is powered by the blockchain system, which determines that it cannot be cracked to reveal the original data. In any case, even if the security structure were breached, the data obtained would be meaningless. This is because the token only contains a reference to the data, not to the data itself. The tokenization process is designed according to the original protocol of synthetic assets, which can be and most often is both decentralized and distributed. It is worth mentioning here that the underlying asset that serves as a building block for the token can be any type of asset. Relatively popular in the recent past were tokens whose underlying assets are works of art in digital form, i.e. NFT. This mechanism clearly illustrates the scope and scale of the financial revolution that constantly accompanies synthetic assets in the DeFi ecosystem.
What are the advantages of trading synthetic assets?
At the very beginning, it should be said that trading synthetic assets brings many significant advantages, including those that are directly related to investing in traditional derivatives. Only part of the benefits of trading these innovative digital derivatives relate to the exposure risk hedging model, market efficiency, as well as access to hard-to-reach assets or markets. Thanks to the operating architecture of synthetic assets, these advantages are significantly extended. Synths provide incomparably greater liquidity than can be imagined in the case of traditional derivatives, even those with access to the global market. Any user of decentralized finance can issue synths or tokenized derivatives using decentralized finance protocols for this purpose. The ease of creating synthesizers causes the ever-growing popularity of NFT use in the DeFi sector. Above all, synths and tokenized derivatives provide seamless movement in a global trading system based on the concepts of DeFi and blockchain technology. DeFi eliminates the role of unnecessary financial intermediaries who unfairly inflate transaction costs, especially in the case of cross-border trade. Trading synths in DeFi is extremely low cost and does not have any geographical restrictions. What's more, investors can enjoy anonymity, which, for obvious reasons, is missing on centralized exchanges operating in the sphere of traditional finance. All transactions can be easily tracked in a distributed ledger, and privacy is the cornerstone of synthetic asset trading.
What is mirror trading with synthetic currencies?
Mirror trading is a type of investment strategy that allows traders to copy trades that are executed by experienced professionals. It is traditionally assumed that this is a popular strategy used mainly in the forex markets. In the DeFi ecosystem, the creation of synthetic derivative assets provides a great opportunity for novice traders to mirror the trades of seasoned traders. To put it simply, mirror trading is possible thanks to the use of synthetic currencies whose primary task is to reflect the behavior of real currencies. Most importantly, DeFi mirror trading with synthetic currencies covers the cryptocurrency sector, which in this case can perfectly mirror the price behavior of any other asset. This solution allows investors to trade fiat currencies that are backed by economic and political stability. By developing a mirror trading model, the novice trader has the opportunity to truly reap the same financial benefits as experienced traders, while avoiding the high trading and asset management fees that professional fund managers charge for their investment strategies. Mirror trading with synthetic assets is another completely new way in which the decentralized finance sector opens up opportunities for high profits for novice and inexperienced traders in the financial markets.
