Crypto Synthetics or "Synths" give investors the possibility to trade or buy a specific asset in another blockchain. They also help manage risk and use a wide range of investing strategies.
The different theories about "Parallel Universes" or what is now known as "Multiverse," not to confuse the Metaverse!. Thanks to the comics and movie industry, they have become widely known, which have created many stories based on these concepts. Therefore, it should not be weird that the cryptocurrency ecosystem also has its version of "Multiverses." It has different versions of the most popular coins. Of course, it is where synthetic crypto-assets are born.
Synths and derivatives
Crypto synths are part of a broader set of financial instruments known as derivatives. Futures, options, and synths are part of this group. Futures and options usually represent agreements to trade a specified underlying asset at a future date at a predetermined price. Synths represent another asset, usually on a different blockchain network.
The concept is not new since they practically come from synthetic assets used in the traditional stock market to control risks associated with market operations. The result of financial engineering, these assets are a combination of a financial asset (any) with a derivative instrument, which modifies the expected returns or risks of the reference asset.
The main characteristic of synthetic assets lies in their combined power, which makes it possible to achieve different investment strategies and mirror replicas of certain financial assets in the market. Their existence arose from the need to incorporate new products as markets evolved, creating innovative financial instruments that offered alternative solutions to investment and market problems, controlling volatility, risk, or liquidity.
Uses of Synths
Hence, "synthetic" crypto-assets or "synths" are also used to simulate particular instruments while modifying some key characteristics, allowing investors to gain exposure to the underlying assets without necessarily owning them. Think of trading coffee without actually storing it in some warehouse.
Positions in "synthetic" crypto-assets form a wide range of possibilities for investors as they allow diversification of trading positions and sometimes significantly limit the associated risk (Hedging).
Therefore, the most coveted feature of "synthetic" crypto-assets is the ease of creating cross-chain assets. The name of such assets is "wrapped tokens." You can mint them by wrapping a crypto asset, which can be returned to its original form by "unwrapping" it.
For example, Bitcoin (BTC) is the king of cryptocurrencies in our known universe because it has the highest market value and the largest market cap of digital assets. But in another universe, the cryptocurrency created by the mysterious Satoshi Nakamoto has its parallel version.
The Wrapped Bitcoin (WBTC) is a synthetic Bitcoin, created as an ERC-20 token within the Ethereum blockchain, which has a mirror quote of BTC but lives on inside the robust Ethereum network.
Right now, the market cap of WBTC alone stands at $12,125,000,000, with the number of holders steadily growing month after month, demonstrating the growth in popularity of this "synth."
People created these "synthetic" crypto-assets in the cryptographic ecosystems due to the problem of interoperability between different blockchains, which imposed limitations to exchange value between other blockchains.
Hence, a simple exchange operation from Bitcoin to Ethereum or vice versa was a challenge due to the difference in their underlying protocols and fee handling. So to solve it, it was necessary to create a synthetic version of Bitcoin, but within the Ethereum network.
This synthetic Bitcoin should allow the possibility of trading and operation in fully decentralized exchanges (DEX) in a fully autonomous manner, which is currently one of the pillars of DeFi. Developers started a whole new wave of synths from here.
People created WBTC to solve the transfer between both blockchains, representing BTC within the market. Inside the Ethereum blockchain, it allows interaction with the network and benefits from its network properties without having the original asset.
It's worth mentioning that this is not limited only to Bitcoin and Ethereum, nor to WBTC, since any cryptocurrency, asset, or metal that needs portability to another blockchain will have its "synth" since it is the way to introduce tangible assets into the blockchain. The same applies to corn, coffee, or wheat. Through synths, investors get exposed to the value variation of the "original" instruments within a particular blockchain.
In other words, these "synths" can be a Decentralized Autonomous Organization (DAO) or a Smart Contract within the Ethereum network or another, which allows exchanging the synthesized asset, so that the investor can have access to use all the qualities of that network as if he had the tokenized asset at his disposal.
Once inside Ethereum, the owner of the WBTC, owns a crypto-asset with the mirror market value of Bitcoin, but with the power of this network, being able to access from NFT purchases, flexible savings, yield farming, loans, fixed terms, passive returns and other solutions available in the DeFi universe.
The WBTC purchase process is the same as any other cryptocurrency. The exchange operation is 1:1 between your traditional BTC and exchanges them for WBTC as if you were acquiring a stablecoin.
The use of this type of "synths" has skyrocketed since the end of 2020. Throughout 2021, "synthetic" crypto-assets were included in one of the leading crypto exchanges in the United States, beginning to arouse the interest of investors.
Exchange adoption, coupled with the spike in cryptocurrency use that the crypto market had since mid-2020, along with the explosion of DeFi products and NFTs, began to give them greater visibility and exposure, turning them into investment alternatives and as an invaluable trading tool.
One of the most popular alternatives to dollarize an investment portfolio are stablecoins. They have a stable price, tied in parity to a fiat currency, either the dollar, the euro, the yen, etc., which, together with "synths," open a range of possibilities to traders.
Although people are still afraid of the general volatility of cryptocurrencies, the truth is that the "synths" and stablecoins helped many traders to manage their portfolio and market risks. In general, derivatives help hedge the everyday risks present when investing in crypto (or any other market.)
Everyone knows that during bearish or highly volatile times, investors tend to protect themselves by resorting to stablecoins. But when combined with "synths," thanks to the fact that they can be on the same blockchain, their movement is more agile with a smaller amount of fees. In TradFi, some traders profit and trade volatility. Volatility trading is known as Vega trading since the most important metric is a magnitude named Vega that measures how the price moves if the volatility changes.
In addition, now that people started to know what is staking and use it as a viable profit opportunity, synths can be kept blocked, and rewards can be collected in a stablecoin or passed directly to it. These, among many others, show the benefits of using synths alongside stablecoins.
However, "synthetic" crypto-assets go further, as they possess the ability to tokenize any real-world asset on the blockchain. Thanks to synths, from stocks, commodities, metals, futures contracts, memes, drawings, and artwork, you can tokenize almost anything thanks to "synths." This process is known as tokenization.
"Synthetic" crypto-assets have all the advantages of crypto, such as permissionless issuance and global liquidity. On the other hand, they do not possess the risk of centralization, as no central entity has control of the creation and settlement of derivatives.
In essence, "synthetic" crypto-assets exist on several different types of blockchains, Ethereum, Binance Chain, ChainLink, among others. As we have seen, "synths" additionally possess the ability to be more agile and versatile, retaining the characteristics and market value of the synthesized asset.