A Beginner’s Guide to Synthetic Assets
If you believe you’re considerably clueless about the term ‘Synthetic assets’ and want to know what it’s all about, welcome. The term is somewhat explanatory in itself: ‘Synthetic’ refers to something that is artificial. Lying somewhere in the same ballpark, synthetic assets are those assets which do not actually have a value of their own, but imitate other financial instruments.
To define them in a more precise manner — synthetic assets are a combination of assets which act like another asset. In order to get a more wholesome understanding of what they are and how they are related to the crypto world, we ought to introduce you to a few other terms.
In the classical world of finance, derivatives are contracts made between two or more parties for the sale of an underlying asset after some fixed period of time at a fixed price. These underlying assets could be any kind of financial instrument, commodity, bond, stocks, etc. Understand that derivatives are dependent upon the value of that underlying asset in question.
For example, say you wanted to buy Bitcoin from a holder at $70,000 apiece. You drew up a contract and said to the holder that in 2 months time he would sell it to you (and only you) at the stipulated price. In a show of assent, both the parties agreed to the terms and conditions and signed the contract. Now, in the coming two months, perhaps the price of Bitcoin increases to $90,000. Obviously you, (at the long end) are at a profit when you go up to the holder and demand him to pay up according to his end of the deal.
But, perhaps, in two months time, the value goes down to $40,000. In this case the owner, (at the short position) profits. He now sells something that is now worth $40,000 at $70,000.
This is a very rough idea of what derivatives look like. In reality, there are far more complex technicalities attached to it. But let’s not get too ahead of ourselves.
Decentralized Finance (DeFi) Ecosystem
Decentralized finance refers to a system wherein financial products are accessible on a public decentralized blockchain network making them easily available to the average person rather than just a select few. The system saves time and hassle. The person interested in trading in some form of assets can do so via this network without having to go through middlemen as he would have to do in a more conventional setting.
Instead of being controlled by some financial institution like a bank or another authority, it is regulated via protocols and other similar technologies.
However, this ecosystem is something that is largely in the development stages.
Now, coming to how these two are correlated with synthetic assets tokens.
Synthetic assets are essentially a type of derivative in the virtual world. They too ‘derive’ the value of the assets’ actual equivalents in the real physical world, however, they do so without actually having those assets in their hold. This means that all speculation and trading is done on a digital sphere.
This is also where the DeFi system comes into play. Since the commodities in question are not actually acquired, equivalents of those very commodities are made in the block chain network. This could be anything from gold, oil, etc. All you really need is a good number of people ready to speculate upon future prices.
Why Synthetic Tokens are Booming
Coming to why these synthetic asset tokens are on the rise.
- They decrease the costs involved in funding
- They make the trade of financial assets far more accessible and hence, increase market efficiency. You can literally trade any asset you want!
- Like derivatives, they considerably reduce the risks involved in certain traditional financial sales.
- They promote injection of liquidity into the market.
In short, they are a much more modernised way of entering the trading arena. Whilst speculation is the main game here, there ought to be people who are ready to speculate in the first place.
Synthetic assets can actually be challenging to understand. They’ve also gotten investors into undesired positions loads of times in the finance world.
Still, there is no doubt that synthetic assets continue to play an important role in traditional financial markets and are turning into important parts of the DeFi movement. There is still a lot left unexplored. A lot of plains which must be discovered.
This is an arena where XCarnival swoops in and saves the day. Not only do we usher in a much simpler path for the not so well-informed audience interested in synthetic assets.
With services like XBroker, XArena and XAdapater, we lead our own way in a user-centric approach to maximise liquidity using flexible parameters. For more on these services, follow our blog.