---
title: 3.5 Synthetic Assets
description: Understanding Synthetic Assets as a DeFi Primitive
---

# 3.5 Synthetic Assets

Synthetic Assets represent one of the most promising, yet also one of the most complicated DeFi Primitives. As a warning, this specific DeFi primitive remains in its infancy, with less product market fit than its peers (Lending, Trading and Stablecoins). Nevertheless the promise of synthetic assets is absolutely enormous. 

## What Are Synthetic Assets?

Synthetic assets refer to tokenized markets representative of real-world financial instruments. However, because they are not the actual financial instrument, they are considered ‘derivative’ forms of value, directly tied to the real asset in question. This could be a stock, a bond, a commodity, an index, and so forth. The big _idea_ behind synthetic assets, is to bring the existing financial system on-chain such that any user can benefit from _global, 24/7, permissionless, and composable_ engagement with an existing asset - without actually having to own the asset in question. 

For context here, the belief that someday, someone can buy a basket of stocks representative of companies from around the globe, in one single click - without needing a license or approval - is rooted in the promise of Synthetics in crypto. With Synths, I can long a Japanese railroad company, and short a Tajikistan cement company, while also buying Google and Amazon - all on-chain, and all without going through the specific jurisdictional indices, that have traditionally limited investment in national stock markets. 

The Total Addressable Market (TAM) of Synths is in the trillions - yet it still remains relatively unpopular in crypto. Why is this? 

## What Is The ‘Hard Part’ About Synthetic Assets?

From a technical point of view, all synthetic markets require extremely reliable price oracles in order to connect an off-chain asset with an on-chain derivative token market. The entire success of a synthetic market, centers on the Oracle's ability to maintain an accurate and up-to-date price feed on the underlying asset market. 

Beyond this technical limitation, there are three main challenges with synthetic assets: 



1. **_The Quantity of Potential Markets:_** Unlike a lending protocol or a decentralized exchange, a separate market must be created, with sufficient liquidity in each market to enable reliable trade executions. 
2. **_The Collateralization Ratio:_** Because the ultimate price or value of the underlying asset is correlated to the real-world asset, and not the market - participants in a synthetic market must collateralize any market they wish to create. Usually, this is done using endogenous ecosystem collateral, where the ratio required is upwards of 650%. 
3. **_The Sustained User Interest_:** If users could have access to the actual asset through a stock broker or a service like _Robinhood, what_ would drive the interest to participate on-chain, when you need to use your own collateral in order to create or trade a market? In other words, why would the world benefit from moving stocks, bonds and commodities on-chain? While in the long-term there is a clear advantage to moving assets into a single distributed ledger - it is unclear whether synthetic assets will succeed in mirroring the real world, or whether the real world will migrate on-chain. 

## Examples of Synthetic Asset Protocols

### [Synthetix](https://staking.synthetix.io/)
Synthetix is the oldest and most successful Synths protocol to date - originally launched in the 2017 ICO boom. With [320mm in TVL to date,](https://defillama.com/protocol/synthetix) it remains the most popular synthetic asset market in crypto. During the bull market of 2021, it reached a peak TVL of over 3 billion. 

_Token Functionality:_

SNX is used as collateral to mint synthetic tokens - specifically sUSD, which can then be leveraged in certain pools to speculate on expansion or contraction of the different derivatives. However this comes with a high requirement of a 650% collateralization ratio (decided on by the DAO). Note that the value here is endogenous value, minted out of the SNX token and no underlying asset. 

Beyond staking SNX to mint synthetic value, if a user is able to maintain their collateralization ratio above 650% (or whatever set by the DAO), they are also entitled to receive exchange fees denominated in sUSD by users on the platform. 

_Mechanism Design:_

SNX is the basis of an ecosystem which does not rely upon exogenous value, but rather seeks to export its own endogenous value. Stakers leverage SNX to mint sUSD and to earn fees from traders on the platform. Traders swap ETH for sUSD from which they can trade on the different derivatives markets. The DAO as a whole manages collateralization ratios for the minted assets, and is at liberty to increase or decrease the rate.  

### [Mirror Protocol: ](https://mirrorprotocol.app/#/trade)
Mirror remains an honorable mention, as it [suffered a number of exploits and hacks,](https://therecord.media/mirror-protocol-suffers-2-million-exploit-after-90-million-stolen-in-october/#:~:text=Mirror%20Protocol%20was%20built%20on,and%20its%20sister%20token%20Luna.) before collapsing from the UST de-pegging event. At its peak, Mirror was home [to over 2 billion dollars in TVL](https://defillama.com/protocol/mirror). Due to the fact that Mirror was built on top of the Terra blockchain, and LUNA / UST collapsed to zero, Mirror was easily exploited with its underlying blockchain nuked to zero. Specifically a price exploit took advantage of a price oracle switch between the classic LUNA asset and the new LUNA asset. 

### [Kresko](https://www.kresko.fi/) 
Kresko is an up-and coming Synthetics solution built on Optimism, that is seeking to re-think how synthetic assets exist on-chain. Rather than starting from the synthetic asset markets themselves, the Kresko team has taken a step back, and instead has focused on creating a layer or liquidity, such that it can power both synthetic assets as well as other DeFi primitives. 


![](@site/static/img/bootcamp/mod-em-3.5.1.png)


The place of synthetic’s in Kresko is novel, insofar as it see’s successful synthetic design as a piece of a larger liquidity protocol offering swapping, lending and other DeFi Primitives. 

## Will Synthetic Assets Eat The World Of Existing Finance?

The movement of real-world assets on-chain is inevitable to many investors and commentators. From [Balaji’s DeFi Matrix](https://twitter.com/balajis/status/1364626032771272706), to [the CEO of Blackrock ](https://twitter.com/Vic_Vinegar_GMI/status/1598905515253575680?s=20&t=L5w9RT3v_px1pgX0flLNWQ)discussing tokenized stocks and commodities, many serious thinkers in the financial world see the future of finance intersecting quite heavily with distributed ledgers. 

The question for Synthetic markets, however, is whether there is room for these instruments, in the interim? That is to say, is there sufficient liquidity, interest, and collateral, to create liquid and sustained synthetic markets? Or, are we more likely to see new companies publicly listing on-chain such that the native asset itself eventually becomes tokenized, without even listing on an existing financial index? In this scenario, the native token itself could be listed on any order book DEX and benefit from any existing derivatives market - and just like that Synthetics are no longer relevant.