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What Are Synthetic Assets on Ethereum?

Hey folks, don't let the name "synthetic assets" scare you off; they're actually not that hard to understand.

You can think of them as a kind of "digital shadow in the virtual world."

What does that mean? Let's say you want to buy Tesla stock on the US market, but you don't have a US brokerage account, and the process is complicated. This is where synthetic assets on Ethereum come in handy.

On a decentralized finance (DeFi) platform, you can buy something called sTSLA (the 's' stands for Synthetic). This sTSLA is not actual Tesla stock itself; you won't become a Tesla shareholder. However, its price will, through a specific mechanism, perfectly peg and track the price of real Tesla stock.

If Tesla stock rises by 10%, the price of your sTSLA also rises by 10%; if Tesla drops, your sTSLA follows suit.

So, in essence, a synthetic asset is a "price certificate" created on the blockchain that simulates the price of another asset. By owning it, you gain the right to benefit from that asset's price fluctuations without needing to physically hold the underlying asset.

How Are They Implemented? Sounds a Bit Magical, Right?

This relies primarily on two core components: Over-collateralization and Oracles.

Over-collateralization
- This "shadow" needs some value backing, right? Otherwise, it would just be air.
- To create (or "mint") an sTSLA worth $100, you can't just use $100 worth of cryptocurrency as collateral. Because cryptocurrency prices are volatile, if the price drops, your collateral won't be worth $100 anymore, and the sTSLA you created would become bad debt.
- Therefore, the protocol requires you to over-collateralize. For example, you might need to lock up $500 worth of Ethereum (ETH) or other crypto assets to mint $100 worth of sTSLA. This way, even if the price of the collateralized ETH falls, there's enough buffer to ensure that the sTSLA you minted is backed by sufficient assets.
- It's like pawning an item: if you pawn a watch worth $5000, the pawnshop might only give you $2000 cash. This is over-collateralization, for security.
Oracles
- The blockchain itself is a closed system; it doesn't know what's happening in the outside world, so it naturally doesn't know the real-time price of Tesla stock.
- An "oracle" acts as a "messenger." It's responsible for safely and accurately feeding real-world prices (like Tesla's stock price on the Nasdaq exchange) to the smart contracts on the blockchain.
- This way, the sTSLA smart contract knows how much it should be worth, and adjusts its price accordingly.

Let's Look at Some Examples to Make It Clearer

Synthetic assets can simulate a wide range of things; almost anything can be "synthesized":

Synthetic US Stocks: Like sTSLA (synthetic Tesla) and sAAPL (synthetic Apple) mentioned earlier.
Synthetic Commodities: Such as sXAU (synthetic gold) and sXAG (synthetic silver), allowing you to trade gold on-chain 24/7 without visiting a gold shop.
Synthetic Fiat Currencies: Like sUSD (synthetic US dollar) and sEUR (synthetic Euro), which are also a type of stablecoin.
Synthetic Indices: For example, sDEFI (which tracks the price of a basket of DeFi tokens).

So, Why Do We Need These Things?

Sounds pretty cool, doesn't it? Their main advantages include:

Global, Permissionless Access: No matter where you are in the world, as long as you have internet and a wallet, you can trade assets from anywhere, with no account restrictions and no cumbersome identity verification (KYC).
24/7 Trading: US stock markets have opening and closing times, but the blockchain never sleeps. You can trade anytime, anywhere.
DeFi Lego Bricks: These synthetic assets can be seamlessly integrated into other DeFi protocols. For example, you can stake your sTSLA on lending platforms to borrow money, or provide liquidity on decentralized exchanges to earn fees. There are many possibilities.
Smooth Trading Experience: Within the same platform, you can seamlessly swap sUSD for sTSLA, then instantly convert it to sXAU, eliminating the hassle of transferring funds between different markets.

Of Course, There Are Also Risks

Nothing is perfect, and synthetic assets also have risks that need to be considered:

Smart Contract Risk: Code is law, but code can have bugs and be vulnerable to hacks.
Collateral Risk: If the price of the crypto asset used as collateral (e.g., ETH) plummets instantly, it could lead to bad debt and liquidation risks for the entire system.
Oracle Risk: If the oracle feeds incorrect prices or is attacked, the price of the synthetic asset will deviate from reality, leading to significant losses.

To Summarize

Synthetic assets on Ethereum are "digital shadows" or "price mirrors" pegged to the price of real-world assets. Through over-collateralization and oracle mechanisms, they allow you to freely and permissionlessly trade the "price" of almost anything on the blockchain, making them a very powerful and imaginative financial tool in the DeFi world.