What are synthetic cryptocurrencies?
In general terms, synthetic assets refer to derivatives that essentially generate their value from an underlying asset, such as stocks, bonds, commodities or fiat currencies, for example. Analyzing the situation from today's perspective, the global derivatives market, which is estimated at approximately USD 15.8 trillion, is systematically shifting its focus towards blockchain technology. In the cryptoverse, synthetic and mass-minted coins represent tokenized derivatives that are used by investors scattered around the world to trade on the blockchain layer. In illustrating this revolutionary trading system, it is possible to use a kind of mental shortcut and say that a synthetic token is essentially a representation of derivatives based on blockchain technology.
How do synthetic tokens work?
Currently, there are several crypto-based derivatives platforms operating in the crypto space. At this stage, it is worth mentioning that the mentioned synthetic derivatives platforms fall into both the sector of centralized and decentralized trading systems. Irrespective of the technological architecture and operation of individual trading service providers, the introduction of crypto synthetics into the cryptocurrency bloodstream significantly facilitates the issuance, trading and other services related to synthetic assets. To put it simply, synthetic cryptocurrencies have opened up completely new possibilities for all sorts of new types of DLT-based financial investments, with particular emphasis on blockchain technology. From today's perspective, synthetic trading is the perfect way to generate value from derivatives transactions in the blockchain space. What's more, trading synthetic futures is a form of operating classically understood financial instruments, which in this case are based on cryptocurrencies. It is worth adding that synthetics based on cryptocurrencies are becoming more and more popular among investors. From today's perspective, for experienced participants in the digital currency sector, it is no secret that trading synthetic cryptocurrencies is an excellent way to hedge against market risk and volatility accompanying financial markets.
Synthetic cryptocurrencies and traditional synthetic assets
Blockchain technology
The mechanism behind blockchain technology makes synthetic cryptocurrencies safe, transparent and extremely easily identifiable. Since all transactions are invariably recorded in a distributed public ledger, they remain verifiable as well as fully auditable by all participants in the digital currency community. Digitized cryptocurrency derivatives are cataloged online, and investors scattered around the globe receive tokens confirming their ownership.
The model of decentralized synthetic finance based on minted tokens, which is based on blockchain, has many significant advantages from the perspective of the development of finance as a whole. First, property rights are completely indisputable. This is because they are stored securely and permanently in the blockchain. Secondly, it is possible and common for investors to issue a fractional synthetic coin for basically any financial asset. As a consequence, fractional ownership of real assets such as, for example, natural resources, gold, precious metals and even other cryptocurrencies can easily be reflected in a digital record in a distributed ledger. As a whole, the digital currency industry and the entire classical financial sector benefit from unprecedented investment opportunities.
Decentralized Cryptocurrency Finance
Financial models based on cryptocurrency synthetic assets have grown enormously in popularity with the advent of decentralized finance (DeFi). These technologies are based on blockchain-based solutions. Synthetic cryptocurrencies created to automate derivatives markets have implemented the most innovative elements of banking, stock exchange and financial systems with the help of the increasingly popular DeFi sector. First, DeFi works without banks, brokerages or other centralized regulated financial institutions and other unnecessary financial intermediaries. Decentralized finance eliminates problems of the financial system such as non-transparent processes, which have been fully solved in this space due to distributed ledger technology. DeFi also offers investors and the broadly understood cryptocurrency community a number of forward-looking and innovative solutions. This is because this new trend in crypto-finance also shortens the processing time of individual transactions and significantly reduces the costs associated with conducting financial operations. Consequently, international investors are therefore sovereigns. They can seamlessly access synthetic cryptocurrency resources, as well as carry out any transactions in the area of decentralized finance. The parameters described above directly translate into greater liquidity for all types of synthetic cryptocurrencies.
Smart contract functionality
Another thing that is characteristic of the digital currency sector and that distinguishes synthetic tokens from traditional synthetic assets is the mechanism of smart contracts. These self-executing and fully automated algorithms make synthetic crypto transactions more reliable and secure compared to the traditional financial system. Smart contracts are typically designed in such a way that they execute transactions only if they meet certain predetermined conditions and fully exclude the possibility of fraudulent manipulation of transactions on synthetic assets by potential hackers and undesirable third parties.
The introduction of smart contracts to the digital currency sector has also enabled a borderless world of finance. Moreover, synthetic cryptocurrencies offer investors the opportunity to earn passive income and additional rewards through staking, as well as acquiring rights to manage decentralized financial protocols. There is general consensus among investors that they can earn more from trading synthetic cryptocurrencies than from traditional synthetic assets.
What are the disadvantages of synthetic cryptocurrencies?
Despite the objective fact that synthetic cryptocurrencies have a lot of advantages over synthetic assets, they also have some limitations.
First of all, any software is prone to bugs and hacking. In the past, systems based on blockchain technology have fallen victim to malicious hackers many times. Attackers may try to exploit vulnerabilities in smart contracts and embezzle funds accumulated in synthetic asset markets.
Secondly, because the price of a synthetic token always bases its value on underlying instruments from the real world, this model is highly dependent on the blockchain oracle. Computer software called the "oracle" in the cryptocurrency realm provides real-time price data for each synthetic coin. However, since oracles collect all data from external sources, this determines the situation where the integrity of information is sometimes compromised.
Third, the source of a potential problem may be the blockchain itself, on which all kinds of functions that characterize the synthetic cryptocurrency may break down due to scalability issues. It is also worth noting that transaction fees can also be quite high due to network congestion resulting from high user activity. Currently, these problems primarily concern the Ethereum ecosystem. At this stage, however, the positive news is that any inconvenience associated with using this blockchain variant will soon be fixed by updating the network to Ethereum 2.0.
Significance of synthetic cryptocurrencies in the development of the DeFi sector
Despite some minor flaws, synthetic cryptocurrencies have indeed and undeniably already revolutionized the world of finance. The main reason behind this fact is primarily that a synthetic token is much easier to create and trade than traditional synthetic assets. In addition, digital derivatives based on the phenomenon of tokenization have made financial markets incomparably more democratic than ever before. Thanks to the security guaranteed by blockchain technology and reliable smart contracts, synthetic cryptocurrencies will most likely achieve spectacular success in the near future.
Synthetic cryptocurrency assets currently have great potential to finally dismantle traditional and outdated financial systems. Nevertheless, investors should be aware of the fact that a complicated regulatory framework governs the traditional market of synthetic assets, while the domain of synthetic cryptocurrencies is devoid of any legal guarantees at this stage. Despite the fact that a growing part of the cryptocurrency community calls for the regulation of synthetic assets, many believe that regulation of this innovative financial segment is unnecessary.
From the perspective of today, it is difficult to determine the direction of development of the synthetic assets sector and only time will tell what role synthetic cryptocurrencies will ultimately play. However, what we know now is that synthetic tokens are fully ready to sail into the wide waters of the financial world.
