Synthetic protocols

DeFi synthetic protocols allow users to create and trade synthetic assets that replicate the value of real-world or digital assets like currencies, stocks, or commodities.

DeFi synthetic protocols allow users to mint, trade, and hold synthetic assets, which are blockchain-based tokens that represent real-world assets like commodities, stocks, or even fiat currencies. These protocols operate through decentralized mechanisms and enable users to gain exposure to assets without having to directly own them.

Below is an overview of how these protocols work, their key components, and the metrics used to track their performance.

What are synthetic protocols?

Synthetic asset protocols in DeFi leverage blockchain technology to allow the creation of assets that track the value of real-world instruments. These synthetic assets (often called Synths) can include anything from stocks and bonds to commodities like gold or oil. The key innovation in these protocols is that they allow users to interact with assets outside the traditional financial system, all in a decentralized and permissionless manner.

In DeFi, synthetic assets are typically backed by collateral that is deposited by users into the protocol. This collateral acts as a guarantee that the value of the synthetic assets is secured. The protocols are designed to keep these assets well collateralized to ensure their stability. When users wish to create (mint) or redeem synthetic assets, they must provide enough collateral to support the value of these assets.

Key Components of DeFi Synthetic Protocols

Collateralization

To mint synthetic assets, users must deposit collateral. This collateral is generally held in a smart contract and is used to back the synthetic assets. The protocol typically sets a collateralization ratio, which defines how much collateral is required to mint a given amount of synthetic assets. For example, if a protocol has a 150% collateralization ratio, a user must deposit $150 worth of collateral to mint $100 worth of synthetic assets.

Minting and Redemption of Synths

Once users deposit their collateral, they can mint synthetic assets that track the value of an underlying asset. These assets can be freely traded or used in other DeFi applications. When users want to redeem their synthetic assets, they must return them to the protocol, and their collateral is unlocked and returned to them, minus any fees or interest.

Staking and Rewards

Many synthetic protocols also allow users to stake their collateral or native tokens (e.g., USDe, ENA in the case of Ethena) in order to earn rewards. These rewards are typically generated from the fees that the protocol collects from users who trade or mint synthetic assets. Stakers help secure the system and ensure the stability of the synthetic assets.

Fees

Fees are often collected when users trade, mint, redeem synthetic assets or earning yield from deposited collateral assets. These fees help generate rewards for stakers and also support the protocol’s operations. In some cases, the fees may also be used to pay for liquidations or other system-related actions.

Liquidations

To maintain the stability of synthetic assets, protocols have liquidation mechanisms in place. If the value of a user’s collateral falls below a certain threshold relative to the minted synthetic assets, the protocol may automatically liquidate the collateral to protect the system. This is done to prevent the creation of synthetic assets that are not fully backed.

Key Metrics Tracked for DeFi Synthetic Protocols

When evaluating synthetic protocols in DeFi, several key metrics are used to gauge the health and performance of the protocol. These include:

• Outstanding supply: This represents the total value of synthetic assets that have been minted and are circulating within the system. It is a measure of the total synthetic assets issued by the protocol.

• Collateral deposit: This is the total amount of collateral deposited by users into the protocol to back the synthetic assets. It reflects the health and stability of the protocol, as it indicates how much collateral is backing the synthetic economy.

• Supply staking: This refers to the amount of collateral or native tokens (like SNX) staked within the protocol. Staking helps secure the protocol and offers users a chance to earn rewards from transaction fees.

• Liquidation: This metric tracks the value of collateral assets that have been liquidated due to falling below the required collateralization ratio. High liquidation volumes can indicate increased risk or instability in the system.

• Staking ROI: This metric measures the return on investment for stakers. It reflects the rewards earned by users who stake their collateral or native tokens within the protocol, typically from trading fees and other activities.

• Collateralization ratio: This represents the ratio of collateral to synthetic assets. A higher collateralization ratio is a sign of a more secure protocol, as it means the synthetic assets are more fully backed by collateral.