Synthetix is an Ethereum-based DeFi project that serves as a decentralized exchange (DEX) and issuer of synthetic assets in an open, decentralized, and trust-minimized way. It accomplishes this through a staking-based incentive system, while also using smart contracts and oracles.
Users can speculate on any real asset by creating synthetic assets that track their real-time prices. Anyone can gain exposure to stocks, bonds, real estate, currencies, and just about anything with a price, all in a non-KYC system with no central authority. This can be done by depositing SNX tokens on the platform.
- Synthetix (SNX) is a top 10 DeFi token with nearly $2.0B in value locked while showing continued growth since inception.
- SNX staking provides ultra-competitive ROI at nearly ~30% making it attractive to DeFi users seeking yield. SNX also demonstrates an active user base as ~60% of the SNX supply is currently being staked.
- While already proven to be a successful project, SNX has a clear roadmap, growing team, and steady development progress to grow the project which could eventually unlock the global market of trading sythnetics of any asset, currency, commodity, etc.
- Synthetix is a complex trading platform that integrates various early-stage technologies like Ethereum, smart contracts, oracles, Mintr, and more which creates compounding risk for SNX holders.
- Synthetix is not fully decentralized, immutable, or censorship-resistant like other DeFi projects i.e. Uniswap. In fact, Synthetix has a "pause" feature that the team used to stop trading after an exploit in June 2019.
- SNX staking requires ~750% overcollateralization which is cost-prohibitive to most users and far more cost-intensive than other DeFi projects. This could dissuade some users from using Synthetix and instead seek alternative ways to trade/earn yield in DeFi.
- SNX staking is not as "passive" as other projects and requires some additional oversight. The learning curve associated with SNX staking (and the Synthetix ecosystem in general) is higher than other DeFi projects and may discourage some users.
Synthetix is similar to MakerDAO in that a user must lock up Synthetix Network Tokens (SNX) to create synthetic USD (sUSD), similar to how Maker users must lock up MKR to mint DAI. Once SNX is locked in a contract, Synthetix allows issuance of the synthetic assets, Synths, in the form of an ERC-20 token. By using the staking pool collateral model, communication between Synths interacts directly with smart contracts to avoid the need for human counterparty risk. This model also solves the liquidity and slippage (the difference between the expected price of a trade and the price of the executed trade) problems of decentralized exchanges while incentivizing holders to stake their tokens. While staked, each participant is paid on a pro-rata basis (a process where whatever is being allocated will be distributed in equal portions) based on their initial contribution from the fees generated on the Synthetix platform. This asset is mainly used as a debt security to leverage other assets, speculation, and staking. As of Q1 2021, there are only a few types of assets users can collateralize. In Kwenta, Synth’s decentralized exchange (DEX), users can buy and trade 13 cryptocurrencies and inverse cryptocurrencies, synthetic gold and silver, synthetic USD, synthetic Australian dollars, and synthetic Euros. In April 2021, Kwenta launched synthetic stocks like Facebook, Apple, Netflix, Google, Tesla, and more adding to the number of assets supported by the SNX ecosystem. This enables traders to swap cryptocurrencies like sETH, sLINK, sUNI, and more directly for the stocks without interacting with traditional finance. The Synthetix Foundation is working diligently to offer more assets to benefit user adoption and the network's growth. This is still an early and risky project, but the loan and staking applications can supply users with high returns. The platform has a live product that allows users to receive yield via interest right away.
Staking digital assets on Ethereum has captured the eye of traditional finance institutions over the last year. Staking validates transactions on a Proof of Stake (POS) blockchain. By holding SNX tokens, users can earn trading fees from the platform in proportion to the number of tokens staked. However, staking SNX is vastly different from other staking systems where interest is collected passively. SNX staking adds a layer of complexity in which, in addition to staking on the network, a user must place a directional bet on an asset (up or down) when staking. This increases the risk and may not be for the average user.
Synthetix recently went live in Q1 2021 with its newest staking mechanism on layer 2 (L2) Mainnet, called Optimistic Ethereum. On this L2, anyone holding the token can validate transactions and earn staking rewards by locking their tokens in the network. However, in its current phase, there is currently no utility for sUSD on this L2.
SNX stakers generate income via SNX inflation and sUSD trading fees. The inflation is programmatic and predictable as it is controlled by the Synthetix DAO. The total synth supply is a function of how much SNX is staked as collateral meaning the more SNX staked, the more synth to market. Additionally, SNX stakers generate income via sUSD trading fees. The fees charged by the exchange are managed by the DAO and, so far, remain around 0.4%.
SNX stakers currently receive an APY of 28.7%, of which ~2.5% comes from sUSD trading fees and the rest inflation.
Traders require both liquidity and stability between a Synth and other crypto assets to make profits from trading. Some Synths trade on the open market, so it is possible for them to fall under the value with the assets they track. Synthetix claims that deviations from the peg are minimal if incentives are effective.
There are three methods to the Synth peg according to the Synthetix lite paper:
• Arbitrage: SNX stakers have created debt by minting Synths, so if the peg drops, they can now profit by buying 1 sUSD at $1 USD.
• sETH liquidity pool on Uniswap: each week, a portion of the SNX added to the supply through the inflationary monetary policy is distributed as a reward to people providing sETH/ETH liquidity on Uniswap.
• SNX auction: A new mechanism with the dFusion protocol (from Gnosis) in which discounted SNX is sold at auction for ETH, then are used to purchase Synths below the peg.
Synthetix will transition to Optimistic Ethereum (OE), a layer 2 scaling solution, in 2021. OE is a type of scaling solution utilizing roll ups.Rollups improve scalability by combining or “rolling up” sidechain transactions into a single transaction, generating a cryptographic proof (called a SNARK), and then submitting only the proof to the base layer. This removes the burden of data on layer 1 while also allowing layer 2 transaction data to be available on Layer 1 for validation. Moving transactions on a rollup layer 2 solution guarantees that one could verify the integrity of the data if it’s actually present. Scalability is improved on the base layer due to the lack of reliance on Layer 1 storage.
Optimistic rollups run an EVM compatible Virtual Machine called OVM (Optimistic Virtual Machine) which removes the compatibility issues that exist in Zk rollups. This is extremely critical as composability is paramount in the Ethereum ecosystem, especially in DeFi. One project working on optimistic rollups is Optimism which both Synthetic and Uniswap plan to use.
The two main advantages of Optimistic Ethereum are lower gas fees and higher throughput. Lower gas fees are great for users and can make the system more efficient. Higher throughput will allow the Chainlink partnership to reduce oracle latency for leverage via Synthetix Futures along with future protocol improvements. The transition will be rolled out in a staged multi-phased plan.
Vulnerabilities with the OE Upgrade
Much like the ETH 2.0 upgrade, Synthetix has considerable technical risk during their switch to OE. Due to the billions under management as well as the complexities of multi-asset trading and financially-motivated staking incentives, Synthetix must take care not to fracture its community during the transition. SNX staking and synth trading, while both critical to the overall network, are underpinned by different economic incentives and architecture. Therefore, upgrading to OE in stages, a staking upgrade (April 2021) and trading upgrade (potentially July 2021) help isolate and manage some of the risk.
The success of this project somewhat relies on Ethereum’s protocol to protect itself from smart contract bugs, high gas fees, and general developer interoperability. Since Synthetix is built solely on Ethereum, any critical bug in Ethereum could have downstream effects on SNX. The layer 2 solution of roll ups also comes with its own complexities as well as competition risk. Another implementation of roll ups, dubbed zk-rollups, is currently being adopted and considered by other Ethereum dApps. If zk-roll ups become the preferred scaling solution, that could leave Synthetix (a bit) fragmented from the rest of the blossoming Ethereum DeFi space. However, this remains a long-tail risk and is it too early to tell. Additionally, Synthetix is vulnerable to sophisticated price attacks via oracles and flash loans as discussed further in our premium report here.