It’s nice to have all these financial systems, but wouldn’t it be better if we could use them without going through all these weird imaginary computer currencies?
Synthetics are tokens the point of which is to retain the same value as another asset (dollars, euros, gold, stocks, bitcoin, etc...).
The idea was originally born because of US regulations, which wouldn’t allow crypto exchanges to take in dollars or permit trading of crypto assets against the dollar without a financial institution licence, being that cryptocurrencies weren’t recognized by governements at the time. However the dollar is the currency of reference for all kinds of trades around the world.
Enter Bitfinex with its subsidiary Tether. The idea was simple, dodge american regulations and allow dollar-denominated trading by creating a token that is always worth a dollar, and exchanging it 1:1 against the dollar, it is therefore a “collateralized” synthetic. This way, it is always possible to buy from Tether 1 USDT for $1 and sell to Tether 1 USDT for $1, so the token will always be worth $1 since if someone sells it for $0.90, Tether will still give you exactly $1 in exchange for it. This ended up being the first synthetic, and the beginning of centralized synthetics. However, doubtful audits (verification by a third party of collateral funds), followed by rumors, news and an official investigation have demonstrated that Tether in reality does not hold the necessary collateral in USD for the totality of emitted USDT.
From there came the competition:
And more. These cryptocurrencies which are pegged to the value of different fiat currencies are called "stablecoins". Since then, all of this had to be decentralized, As each of the previously mentioned asset depend on centralized entities.
Therefore, decentralized stablecoins came to be. These stablecoins are tokens minted on the blockchain using smart contracts.
But since there are no real dollars on the blockchain to back these stablecoins, how are these created?
Well, the first ones such as Maker were also collateralized stablecoins, the mechanism of which is to deposit 2-3 times the value in crypto (at first Ethereum, and now others as well) of the stablecoins to be minted. The smart contract will verify the dollar value of your deposit, then lock it into what is called a "vault" and mint the corresponding tokens (DAI in Maker’s case), thus permitting the creation of a decentralized stablecoin.
If the value of the deposited crypto decreases to the point approaching the value of the DAI minted from it, then it will be liquidated by the protocol so as to recover the corresponding DAI, never leaving a token without a superior collateral to back its value. This is the same mechanism as liquidations on a CEX, and it is essentially a loan, which means the protocol creates money through debt just like traditional banks.
Since then, there are now many other stablecoins, which you may discover on your own terms:
The final step of synthetics, in the context of DeFi, is to be able to have cryptos on the blockchains of other cryptos, to take full advantage of all the available mechanics. Essentially, getting yield on those Bitcoins you bought outside of a change in value by using them on an EVM blockchain like Ethereum, BSC, Fantom or Avalanche and therefore having more of them for free, sounds interesting doesn’t it?
So we have "wrapped" tokens, which are pegged to the value of another crypto, and are always collateralized with the real thing:
Of course, there exist many more synthetics, pegged to cryptos, currencies, shares, indices or even commodities, each more or less decentralized to its own degree.
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