Carefully! Lots of text.
Synthetix is a DeFi protocol for synthetic crypto assets. It emerged after the market crash in 2018 along with Maker, Compound, Uniswap and several other protocols, ushering in the development of decentralized finance, which has become one of the most important sectors in the cryptocurrency market.
Introduction
Synthetix was originally created as a stablecoin project called Havven. It was only later, during the bear market, that it became a synthetic asset protocol. The current Synthetix community pioneered many of the mechanisms that are now considered standard in the DeFi system.
As one of the main components of DeFi on the Ethereum blockchain, Synthetix will remain a key part of it for the foreseeable future, especially in light of the imminent launch of the second layer of the scaling solution.
What is Synthetix?
Synthetix is a protocol that allows the issuance of synthetic assets on the Ethereum blockchain. A synthetic asset can be thought of as a derivative that gives you access to an asset without having to own it.
What can become a synthetic asset, or “synth”? Almost anything that has a reliable feed of quotes. This can include cryptocurrencies such as BTC or ETH, valuable commodities such as gold and silver, and fiat currencies such as USD. There are even inverse synths that track the inversion of the underlying asset. With their help, traders can open short positions or hedge existing assets and positions to farm returns.
The main thing is that thanks to Synthetix, traders can gain access to certain assets that are not available on the network. Synthetix also allows you to create indexes, such as the DeFi Index, which can track the prices of multiple DeFi assets.
How does Synthetix work?
Synthetic assets use decentralized price oracles to track the prices of underlying assets. It is important to note that a “synth” is different from a reserve-backed cryptocurrency such as a stablecoin. Instead of a traditional reserve, various complex network mechanisms and smart contracts give it value.
Thus, BUSD is a stablecoin that represents 1 US dollar in reserve. Similarly, Paxos Gold (PAXG) is backed by physical gold bullion, meaning ownership of PAXG implies ownership of an equivalent amount in the underlying gold reserve. In other words, PAXG is a token that represents ownership of gold.
Synths work differently. They track the value of assets through a complex smart contract mechanism. Owning sXAU does not imply owning gold, but only gives you the opportunity to make money on changes in the price of gold.
So why own such an asset? As we have already said, this makes it possible to make money on price changes without having to purchase this asset. Additionally, synths, being ERC-20 tokens on Ethereum, are also convenient because other DeFi protocols can easily integrate them. Synths can be used as a deposit in Uniswap, Sushi or Curve, provide liquidity with them and receive trading commissions, as with any ERC-20 token.
Synthetix Network Token (SNX)
But what, if not the underlying asset, backs the synthetic assets? First of all, the platform’s own token SNX. And just recently, Synthetix also added support for ETH.
Synthetix is overcollateralized, meaning each synthetic asset has more value than it represents.
Users can start creating synths by staking their tokens (SNX) as collateral. In other words, each synth is a debt on the deposited collateral.
Each debt position must maintain a certain collateral ratio, which is determined by the platform administration. This system aims to maintain sufficient synth collateral and no shortages in the system even in the event of a market crash.
Users staking assets must manually manage this ratio by creating and burning syns (debt) or adding additional collateral to ensure continued ability to earn staking rewards.
Eternal liquidity and no slippage
Synthetix bills itself as an exchange with “infinite liquidity” as there is no traditional order book or slippage. Pricing is determined by an algorithm more similar to an automated market maker (AMM) than a central limit order book (CLOB).
When you make a trade on Synthetix, you are not trading with an individual or a market maker, but rather paying off part of your debt and borrowing the same amount in a new synthetix.
It's a complex system with many nuances, but it's important to understand that trading on Synthetix is not the same as trading through the Binance order book or Uniswap liquidity pools.
Synthetix и Optimism
So why aren't all the NASDAQ listed companies connected to Synthetix yet? The fact is that the fees and guarantees on the Ethereum mainnet are not entirely suitable for most traders and their trading styles. That's why Synthetix contracts will be rolled out in Layer 2 called Optimistic Rollup, which is implemented by Optimism.
Rollups are a great way to scale blockchains. The difference between rollups and other scaling solutions is that their security is ensured by the Ethereum blockchain, while sidechains have security maintained through a specific set of validators. This is the key difference - rollups can have the same scaling benefits as sidechains, such as increased transaction throughput and lower transaction fees, but they do not require a trade-off in security.
However, Synthetix contracts are among the most complex smart contracts. It is not easy to migrate them to such advanced technology in the safest way possible. Optimism has been working with Synthetix for some time and is expected to roll out to the mainnet in summer 2021.
Summary
Synthetix is a synthetic asset protocol on the Ethereum platform. It helps track the price of an underlying asset without users having to purchase the asset. Synthetix is one of the oldest DeFi projects, having a decentralized governance structure through SynthetixDAO. And although the specifics of how Synthetix works are difficult to understand, its prevalence may increase greatly when it is deployed on the Optimism rollup.