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What is Synthetix ?

Synthetix protocol is used to create and trade synthetic assets. Synthetic assets simulate the price action of underlying asset like gold, silver, cryptocurrencies, fiat currencies, equities etc.

Synthetic assets are not a recent development. Synthetic assets like CFD(Contract for differences) are being used extensively in traditional finance to bet on price movement of assets. 

However, synthetix protocol decentralizes the process of creation and trading of synthetic assets using blockchain. There is no counter-party or clearing house, that needs to be trusted to execute trades.

Synthetic assets are denoted by prefix ‘s’, for example, synthetic version of BTC will be sBTC. These synthetic assets are pegged to the price of underlying asset. Traders can buy and sell these synthetic assets to capture the price movement of the underlying asset.

What role does SNX token play ?

Synthetix protocol is build on Etherium blockchain. SNX is an ERC 20 token.

It is basic utility token of synthetix ecosystem. Traders stake SNX token as collateral to mint synthetic version of asset they want to bet on. These synthetic assets can also be traded on decentralized marketplaces like:

Fees generated from these decentralized exchanges are distributed to stakers in proportion to their stake.

Origin of Synthetix

Kain Warwick founded Havven(Crypto project for building stable coin) in 2017. He raised $30 million by selling 60 million HAV tokens in 2018.

Warwick is a graduate of Waverley College. He attended the University of New South Wales where he earned a BSc in Genetics in 2000.

From 2005 to 2009, Warwick played guitar for The Lie Society, a band based in Boston. In 2009, he founded Pouncer a live auction site exclusive to Australia.

From 2010 to 2012, Warwick ran franchisee of the Australian-based retailer of electrical, computer, furniture, entertainment and bedding.

In January 2013, Warwick founded Ai, an online retailer for music equipment. In February 2014, he became project manager at White Labelled, a digital media firm for Australian businesses.

In April 2014, Warwick co-founded blueshyft, a platform that supports over-the-counter bitcoin purchases, deposits into digital wallets, and logistics solutions.

Kain Warwick rebranded the project to synthetix protocol in 2018 after facing stiff competition from many successful stable coin projects. He pivoted the project to create and trade synthetic assets. Synthetix team raised 33.67 million US dollars by selling 65 million SNX in 2017-2019.

The team passed the governance of synthetix project to DAO in 2020.

What problems does it solve ?

Following are the reasons why traders prefer to hold synthetic assets instead of buying real underlying asset:

  • Traders can bet on price action of commodities like gold, oil etc without actually holding them.
  • Unlike ETF, they do not have to trust any counterparty for storing and redeeming underlying assets.
  • Synthetic assets can be traded 24 hours a day unlike traditional markets, which have opening-closing trimmings and holidays.
  • People from anywhere in the world with an internet connection can trade any synthetic assets. For example someone from India can buy synthetic tesla shares even though the company is not listed on Indian exchanges.
  • No KYC is required to trade synthetic assets.
  • Synthetix protocol can be used to mint any synthetic asset which has a reliable price feed. This opens up the possibility of minting a whole new class of synthetic assets, which was not possible earlier.
  • Synthetix protocol employs peer to contract trading mechanism(will be explained later). Hence there is no problem of:
    • Slippage
    • Liquidity
    • Availability of buyers/ sellers

How does it work ?

Traditional exchanges use order book model to match buyers and sellers. This system only works when there are large number of buyers and sellers for the asset.

Synthetix uses peer to smart contract model. Traders trade with smart contracts instead of each other.

This model is much better than traditional barter system in which buyers and seller have to find each other.

Peer to smart contract trading

  • Traders buy SNX tokens from open market and stake them as collateral to mint(take out loan) in any synthetic assets. All such outstanding synthetic assets make up the global debt pool.
  • Traders trade synthetics in decentralized marketplace to represent their market view and generate profit.
  • The global debt pool(total value of all the synthetic assets) changes as some synthetic assets appreciate in value, while others lose value.
  • The trader has to deposit his share of synthetics( calculated based on present debt pool) to redeem his collateral(SNX tokens).

In simple words:

  • The protocol records the percent of debt with-respect-to total debt pool for each trader when he mints synthetic assets.
  • Global debt pool(sum of value of all minted synthetic assets) changes as some synthetics appreciate and some depreciate in value.
  • The trader deposits his loan amount(calculated as percentage of new debt pool) to get his collateral(SNX tokens) back.

How does protocol ensure traders maintain adequate collateral ?

  • Synthetix protocol liquidates SNX tokens of traders whose collateral has fallen below 200% for over 72 hours.
  • No rewards are paid to traders whose collateral ratio is less than 750%.

Synthetix platform demo

Governance model

Synthetix team passed the governance of synthetix project to DAOs in 2020:

Spartan Council (SC)

The Spartan Council (SC) is the governing DAO which currently consists of 8 members. SC conducts:

  • Synthetix Improvement Proposals (SIPs) and Synthetix Configuration Change Proposal (SCCPs) interviews.
  • Coordinates updates with the protocol DAO.
  • Hosts periodic community governance meetings.

Protocol DAO (pDAO)

  • Operates Gnosis multi-signature wallet: owner of the Synthetix Protocol core contracts.
  • Responsible for upgrading and releasing new contracts on behalf of the Spartan Council.
  • Members of the pDAO are appointed by the Spartan Council.

Grants DAO (gDAO)

  • The grants DAO funds public goods such as SNX.tools, SNX.link etc
  • It also funds hackathons and developments out of scope of core contributors.

All the members of DAOs are paid SNX tokens as stipends. This aligns their incentives with the growth of synthetix ecosystem.

Competitors

There are many competitors of synthetix protocol:

None of the competitors have made as much progress and has as much amount of value locked as compared to synthetic protocol.

Future plans

Synthetix is a decentralized protocol. It is governed by DAO which approves and funds future updates. Some of upgrades in pipeline are:

  • Layer 2 scaling solutions: To reduce gas costs and improve throughput.
  • Add new assets: Commodities, equities, options etc.
  • Provide leverage to traders.
  • New order types: Stop loss, take profit etc.
  • Use of other crypto assets as collateral.

How much money does Synthetix protocol have for future development ?

  • Synthetix team raised 33.67 million US dollars by selling 65 million SNX in 2017-2019.
  • The protocol does not have plans for follow on offerings.
  • Synthetix protocol does not have any profit model or ongoing source of revenue.

Tailwinds

  • Range of assets: Synthetix protocol provides a wide range of assets for trading. None of its competitors provide such an extensive catalog of assets.
  • Switching costs: Traders would not want to migrate their portfolio to other projects without strong reasons.
  • Competitors: None of the competitors has made as much progress and has as much amount of value locked as compared to synthetic protocol.

Risks

Synthetix is one of the most innovative project in crypto space. It is the first project to explore possibility of peer to contract trading. This exposes the project to technical and regulatory risks:

  • Price oracles: Synthetics rely on price feed from chainlink oracles. Incorrect pricing data can lead to losses and even liquidation of collateral.
  • Regulations: Governments strictly regulate centralized exchanges. These governing agencies will try their best to regulate synthetix protocol. However, synthetix team has made it almost impossible to control the protocol by handing over the governance to DAOs.

Challeges

  • Scaling issues: SNX is an ERC-20 token.Synthetix protocol is built on Ethereum. Ethereum has limited block space, which makes it difficult and expensive to scale. It also has high gas fees, which discourages participation. Synthetix protocol has two options:

    • Migrate to some other blockchain/ Layer 2 solution.

    • Wait for Etherium to solve these issues.

  • Funds: Synthetix protocol raised a substantial amount of capital during ICO. However, they do not have any ongoing source of revenue.
  • Capital inefficient: Traders have to maintain a collateral ratio of approximately 700% at all times. This is not a very efficient use of capital and reduces effective return on capital employed.
  • Debt owed by a trader can increase/ decrease independent of his original position. This is because debt owed by a trader depends on his as well as others’ performance. Every trader is in competition with every other trader. Synthetix protocol is a zero-sum game: one trader’s profit is another trader’s loss. This is because trader’s debt depends on his share of global debt pool (sum of current price of all the minted synthetic assets).
  • Traders can buy synthetic assets to get price exposure of underlying asset. However, they do not get additional benefits like:
    • Voting rights in case of governance tokens.
    • Dividends in case of equity shares etc.

Tokenomics

100,000,000 SNX were minted and distributed in March 2018:

  • 60% were sold to investors.
  • 3% was reserved for bounties and marketing incentives.
  • 5% was reserved for partnership incentives.
  • 12% was allocated to the foundation.
  • 20% was allocated to the team and advisors.

A new inflationary monetary policy was introduced in March 2019 to reward stakers:

Token Inflation

Crypto protocols can use inflation to reward/ punish certain behavior. Synthetix protocol uses inflation to reward stakers. This has resulted in enormous growth of project in short period.

Synthetix protocol has fix max supply of 245,312,500 SNX. which will be reached in 2024. Inflation will become zero once the complete max supply is in circulation.

Demand pressure

Token’s price increases due to demand pressure.

Demand pressure on SNX token will come from:

  • Traders: They will buy SNX tokens from open market and stake it as collateral.  Synthetix protocol maintains a collateral ration of 700%. This is a massive demand pressure.
  • Speculators:They will buy SNX tokens to bet on future price appreciation.

Market cap

Money markets are a multi-trillion dollar industries.

SNX token market cap will be 700% times larger than the share of money market it is able to capture. The token has tremendous room to grow even if the protocol is able to capture a small share of total money market.

Indicators to watch out for

  • Synthetix Twitter following is growing:
  • Total value locked up in Synthetix protocol is growing:
  • Trading volume has started to pick up:

Future possibilities

Synthetix protocol has the potential to change how money market operate. Some ideal future scenarios for Synthetix protocol are:

  • There are many projects that are trying to tokenize real-world assets like real estate. It is possible that Synthetix protocol start accepting these assets as collateral.
  • SUSD: Synthetic stable coin has the potential to become de facto stable coin of crypto ecosystem. It is decentralized and has collateralization ratio of 700% which is more than any other stablecoin.
  • Synthetix protocol can build synthetic representation of any asset that has a reliable price feed. It is even possible to create a synthetic token that tracks the performance of a football player. The protocol offers endless possibilities of synthetic assets that can be minted using synthetix protocol.

What am I betting on ? - ask yourself these questions

SNX token’s future depends on:

  • More traders buy and stake SNX tokens to mint and trade synthetic assets.
  • Allowing traders to use other assets instead of SNX tokens as collateral is good for the growth of ecosystem, but might not be bullish for the price of SNX token.

Finally, investors buying SNX tokens for speculations should also stake their tokens even if they do not have any plans for minting synthetic assets to benefit from inflationary rewards. 

Do further research

You can continue your research by using following resources:

Further reading