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The word on the lips and in the minds of many people around the world is cryptocurrencies. While the cryptocurrency market continues to flourish, decentralized finance applications on blockchain networks like Algorand have taken the crypto space by storm. DeFi has opened the door for investors to access traditional financial services like lending, borrowing, trading, direct swaps, and earning interest on savings in cryptocurrencies. Meanwhile, the crypto boom has made cryptocurrency exchanges prize platforms, with traders, investors, and enthusiasts keen to buy or sell their favorite coins. While regular crypto exchanges offer specific trading services like swaps, spot, and margin trading, synthetic exchange platforms provide a unique asset class to the crypto space.
Synthetic Assets Explained
In the early days, traditional finance offered traders the opportunity to invest in stocks, assets, or commodities. There was little to no flexibility then, and traders could only sell their holdings at the trading day's close. The introduction of derivatives spelled out a new age for the financial market. They (derivatives) presented an opportunity for traders to profit from the price fluctuations of stocks, bonds or currencies, without owning them. Derivatives, essentially, are representations of specific assets, commodities, or currency pairs that traders can buy or sell but do not own. They are also elastic as they introduced much-needed flexibility to traditional finance, since they could be traded at any time in the trading day.
In blockchain technology and cryptocurrencies, synthetic assets refer to tokenized derivatives of cryptocurrencies or any other asset class. Instead of buying gold or Bitcoin, for instance, traders can buy a tokenized version to make profits from any price movements. Unlike regular assets in centralized exchanges, synthetic assets are built on the blockchain, and there is a record of every transaction. In essence, synthetic assets are cryptocurrencies tied to the value of an existing coin, stock, or commodity. Blockchains like Algorand allow for the creation of synthetic assets through the Algorand Smart Contracts feature.
Synthetic Exchanges Unboxed
A cryptocurrency exchange that offers tokenized versions of assets for trading is regarded as a synthetic exchange. Some crypto exchanges offer regular assets and synthetic assets to traders, while others are dedicated solely to tokenized derivatives. Synthetix—one of the earliest and most significant synthetic exchanges—is a typical platform that offers this type of tokenized asset for trading. Others like Cream Finance, UMA, and MakerDAO are also notable examples of synthetic exchanges.
How do Synthetic Exchanges Work?
Exchanges differ from one another, with centralized and decentralized exchanges having significant differences in their structures, modes of operation, and features. Cryptocurrency exchange platforms that offer tokenized derivatives operate differently than regular exchanges. Instead of allowing traders to buy and hold a particular coin, they peg the tokens to the value of existing tokens, meaning a rise or fall in the price of the base cryptocurrency affects the value of the derivative.
How do exchanges peg the value of a token to another? Synthetix—the most prominent platform offering tokenized derivatives of assets—requires users to hold its native token $SNX as collateral. Essentially, when a trader buys a synthetic asset, they only deposit money based on the coin's value; then, the purchase transaction is registered on the blockchain as a cryptocurrency. As the coin's value fluctuates, so does the value of the derivative.
On Algorand, smart contracts can peg the stakes of the native ALGO token against the value of an artificial asset and change the corresponding worth as the real-time prices fluctuate.
Synthetic Exchanges Built on Algorand
The Algorand blockchain prides itself as a green blockchain in light of its low emissions and low power consumption. Also, Algorand's layer one (L1) smart contracts allow developers to build decentralized applications on the blockchain. Most of these DeFi applications are dedicated to financial services, as the term decentralized finance implies, and they include exchanges, lending platforms, and yield farms.
Algorand recently announced a $300 million fund for DeFi projects in its ecosystem. The fund aims to incentivize new DeFi projects, which will also include exchanges that offer synthetic assets. Project developers and teams will receive their share of the fund in ALGO tokens. Algorand's smart contract function is perfect for developers to build synthetic assets and exchanges to bring them to traders. Undeniably, synthetic assets are the future of DeFi.
