Synthesizing a better future for DeFi: 5 Protocols leading the way

The rapid growth of DeFi (decentralised finance) shows no sign of slowing down and, as attention and investment in the space increases, everyone from the legacy Wall Street trader to the everyday investor seems to want a slice of the DeFi cake. With accessibility, security and cost-efficiency in being the keys to mainstream adoption, decentralized money market platforms such as Compound are taking strides in interoperability measures to offer the best user experiences possible. At the same time, DeFi index funds such as those offered by DeFi Pulse and Bitwise are receiving considerable attention from traditional fund managers and individuals looking to “set and forget” their investment assets.

Many of today’s DeFi protocols do their best to look and feel similar to traditional financial products, with money markets such as MakerDAO enabling users to swap, borrow or lend tokens, also offering the ability to trade tokens with margin and leverage. But one of the game-changers that makes DeFi so unique is the introduction of synthetic assets - synthetic assets are digital representations of derivatives that are decentralized, permissionless, freely transferable and tradeable on the increasingly popular DEX (decentralized exchange) platforms gaining growing traction in the blockchain and finance space. 

Synthetics are playing a large role in further “normalising” DeFi for traditional traders and investors, effectively mirroring the role derivatives play in traditional finance; by tokenizing physical assets and commodities such as the popular stocks SPY and TSLA, synthetic products can be used as collateral in other DeFi protocols such as Aave.

But the power of synthetic assets is not limited to one use case alone: exciting projects, some of which are listed below, are also using the versatility of synthetics in an aim to tackle issues that affect the overall efficiency and very inner-workings of many of today’s blockchain projects and ecosystems. In this article I’ll be shining some light on 5 protocols that are unlocking new types of potential for the future of decentralized finance with the help of synthetics.

As previously mentioned, synthetic assets can be used to give users exposure to a variety of different assets without needing to hold the underlying asset itself; this asset can be anything from the US Dollar or the Japanese Yen to physical commodities like gold or silver, with digital assets such as index funds also an option.

With more traders and investors taking interest in DeFi everyday, blockchain platforms are now looking to bridge the gap between CeFi and DeFi by offering users an experience that is similar to what they are used to in the centralized finance world, but that also promises the added benefits of decentralization such as immediate transaction finality, a lack of middlemen, and trustless security. DEUS Finance is one such platform, enabling users to trade a wide variety of real-world assets and derivatives such as stocks and commodities, directly on the Ethereum blockchain. 

On the Deus platform, mirrored assets called “dAssets” are continuously and unbreakably pegged to their real-world equivalent assets at a 1:1 ratio, with the user able to trade them just as they would any other ERC-20 token. The mirroring of both crypto and non-crypto assets is oracle-verified, as is the creation of asset-backed baskets which is also offered to users.

Controlled by a DAO (decentralized autonomous organization), DEUS Finance’s council is made up from various individuals with professional backgrounds in crypto-economics, finance and mathematics, but there are plans to migrate to a community governed and completely decentralized model in the future.

Having recently launched on the XDAI blockchain and with plans to launch on Binance Smart Chain in the near future, DEUS will be available to use on three blockchains and offers a wide range of trading options to users that span everything from BAAKT Futures to synthetic Tesla and Apple stocks. The project recently successfully completed a bonding curve token sale and both of the platform’s tokens, DEA (a governance and liquidity pair token for use in farming pools and future voting rights) and DEUS (which represents a share of the DEUS ecosystem) are now tradable on the cryptocurrency market.

In January the project also announced the unveiling of DEUS Vaults, which enables participants to lock up DEUS, DEA or LP tokens for up to six months, in return being rewarded with interest on their assets.

The derivatives market had an estimated market cap of $1.2 quadrillion by the end of last year, which is about 3000 times larger than the entire cryptocurrency market combined. Bridging the crypto world with traditional finance could see much of the billions of dollars traded around the globe daily trickle into decentralized protocols and platforms, but this isn’t just good for the blockchain and DeFi space; it also means that many millions of people around the globe can gain exposure to assets which would otherwise be out of reach.

Today’s legal frameworks mean that traditional derivatives are reserved for accredited and institutional investors only, meaning that the barriers to entry are too high for the everyday investor. UMA (which stands for Universal Market Access) looks to accelerate a cambrian explosion of DeFi adoption by making synthetic asset trading available to anyone, anywhere. Any two counterparties can design and create their own financial contracts and custom collateralized synthetic ERC-20 tokens on the Ethereum blockchain with UMA’s open-source protocol, safe in the knowledge that everything is secured through economic incentives (that being collateral) and enforced through the power of Ethereum’s smart contracts.

Legal recourse within the cryptocurrency world has been notoriously difficult in recent years; the pseudo-anonymity of users and many project teams combined with the decentralized, permissionless nature of blockchain has meant that taking action against bad actors or issues can be capital, time and resource intensive. UMA gets rid of the need for legal recourse and instead offers a trustless, permissionless mechanism that secures contracts by economic incentives.

Many of today’s DeFi models in existence today rely on oracles for real-time valuations, dispute resolution and settlements, but the issue with oracles is that, as we have seen during black swan events, they are prone to failure and can also be manipulated by bad actors. Instead of using a price oracle to determine when a token issuer is undercollateralized, UMA Protocol uses self-enforcing financial contracts, with users on the platform given financial incentive to identify and liquidate suspected undercollateralized token issuers. UMA’s oracle is only utilized to resolve disputes about liquidations.

Interestingly, UMA recently announced the unveiling of uSTONKS in collaboration with Yam Finance through their collaborative project, Degenerative Finance. which will be a synthetic assets that tracks an index of the ten most bullish stocks according to the now well known WallStreetBets. The asset will track the sentiment of the r/WSB Reddit community and, through this combined effort, both teams look to “give DeFi users more of an opportunity to express their opinion outside of the confines of the traditional finance ecosystem”, which recently saw popular trading platform Robinhood temporarily halt Gamestop trading due to price volatility. 

Looking away from the already highlighted use cases for synthetic assets for a minute, we turn to another use-case, and one which could be a game-changer for the troubling hyperinflationary token models that are all too prevalent in today’s crypto space. As anyone part of blockchain and crypto communities will know, reward mechanisms and incentives can take their toll on token economic models. These mechanisms involve regularly taking from the baskets of token treasuries in order to facilitate participation by communities that would arguably go elsewhere if not rewarded.

The cryptocurrency space is, now more than ever, flooded with projects attempting to “one-up” each other by offering the best rewards to their early adopters and network participants; this is unsurprisingly not a sustainable way to run a project, with many tokens losing their value due to rampant hyperinflation. Rampant inflation has seen the price and utility of tokens in DeFi and blockchain economies crash to near useless at times. DAFI, a project coming out of the UK and incubated by the Royal Bank of Scotland, offers a solution - by inserting an intermediary, elastic unit into token economies, DeFi protocols can effectively say goodbye to hyperinflation, instead switching to a demand-pegged inflation token model. 

DAFI Protocol differs from the other projects on this list, as it utilizes synthetics not just to represent the value of an underlying asset but to solve a burning issue that lies at the heart of many DeFi token economies. Tackling the problems that hyperinflation causes to so many otherwise promising DeFi protocols, DAFI introduces synthetic inflation by means of an elastic intermediary - the “dToken” pegged to projects’ native tokens can be issued for staking, liquidity or participation rewards. The dToken can also be burned for DAFI tokens at any time, giving flexibility to an already intuitive synthetic product.

With DAFI, DeFi and blockchain projects can mint synthetic tokens that represent the ownership rights to their original tokens, after depositing a percentage of their total supply into the DAFI protocol. These synthetic tokens are minted and distributed to holders but are not tradable, meaning that their only use is exchanging them back to the project’s initial token after a predetermined period of time - token holders cannot monetize the synthetic tokens while they hold them, encouraging healthy token holding and a sustained token economy.

DAFI using synthetic assets in this entirely novel way enables projects to stop relying on inflation of their own valuable token treasuries just to incentivize and reward their communities, and means that token economies can concentrate on prolonged and sustainable growth with a reliable framework in place. Having recently partnered with several exciting projects in the blockchain space including Gather and Razor, DAFI has a public token sale coming later this month.

As the rich get richer, it is more apparent than ever that the scales are tipped in the favour of  the “1%” and the gargantuan financial institutions and conglomerates that run the world’s best known brands. When it comes to financial inclusion, this disparity can be pictured as a fence between the everyday investor and the multi-billion dollar trading firms that move markets on a daily basis - let’s just say that this fence is pretty much too high to peek over for most.

One of the main missions of DeFi projects and the crypto communities that underpinning them is to open the gates for broader financial inclusion to the many millions worldwide that still have limited or even no access to basic financial tools; with a game plan similar to that of the aforementioned UMA, the team behind Mirror Protocol want to grant intuitive access to global financial markets for disenfranchised users around that world that are precluded from specific international markets for various reasons. 

As a synthetic asset platform Mirror Protocol offers anyone in the world with an internet connection exposure to “mAssets” which are synthetic tokens that reflect traditional assets (currently U.S. equities). Unveiled by and running on Terra Network, the mAssets created by Mirror Protocol effectively mirror the price behavior of the underlying real-world asset. These synthetic assets can be traded on AMM exchanges such as Terraswap, Uniswap and more recently Binance Smart Chain.

The ability to tokenize anything anywhere, at any time goes beyond stocks and shares though, and with Mirror Protocol users can tokenize real-life assets such as real estate, precious metals, art or indeed any other commodities and illiquid assets. The mAssets created by users can be utilised for a variety of purposes - they may be traded, held, or used for adding collateral in creating new mAssets, synthetic stable pools, liquidity pools and much more.

Having partnered with BAND Protocol, Mirror uses their Oracle to implement price feeds for an initial set of assets covering blue-chip stocks, commodities and ETFs. The project also in January partnered with web plug-in MASK Protocol to enable the trading of mAssets to major social networks such as Twitter.

Mirror Protocol was created by Terraform Labs which itself was founded in 2018 and is backed by the likes of Coinbase Ventures, Pantera Capital, Polychain Capital, Galaxy Digital, and Arrington XRP Capital. Well known exchanges such as Okex and Binance Labs have also publicly supported Terraform Labs.

As we have by now established, synthetic assets are powerful because they offer users around the globe access to a wealth of opportunity with all the benefits of decentralization, and no discussion of synthetic assets in the DeFi world would be complete without the mention of Synthetix. This was the DeFi protocol that started it all, pioneering the usage of and the mechanisms behind synthetic assets and it is the biggest derivatives protocol on the Ethereum blockchain with nearly $2.5 billion in value locked inside the protocol at time of writing.

Synthetix is a protocol that enables the issuance of synthetic assets on the Ethereum blockchain, supporting fiat currencies, cryptocurrencies (long and short) and commodities. Originally launched as Havven (HAV), a decentralized stablecoin protocol, Synthetic rebranded and now offers users a wide variety of options for synthetic asset creation and on-chain exposure to real-world currencies.

By staking the protocol’s native SNX token, users can synthesize their own assets on the Mintr dApp; all Synths created by staking SNX tokens are backed by a 600% collateralization ratio, which is determined through community governance. Stakers are incentivized to create Synths through  receiving the rights to a fixed amount of inflation as well as fees on the trading of the Synth itself, but they also incur debt when they mint Synths and to unlock their staked SNX tokens they must burn a proportion of Synths they minted.

The synthetic assets can then be traded on Kwenta, Synthetix’s decentralized exchange and include everything from cryptocurrencies, indexes and inverses to real-world assets like gold. The project also recently unveiled plans to offer synthetic DeFi tokens for the likes of such as Aave, Uniswap, Yearn.Finance, Polkadot, REN, and Compound.

Having received investment from several well known funds including Three Arrows Capital, Synthetix successfully completed their public token sale back in 2018 and has since received a further $12 million in investment from venture capital firms Coinbase Ventures, Paradigm and IOSG. 

In an exciting move for the world of digital assets trading and blockchain technology in general, Synthetix is set to be one of the first protocols to migrate to Optimism’s solution to Ethereum’s transaction problem, the Optimistic Virtual Machine (OVM) which soft-launched back in January. This move will decrease transaction fees, speed up finality and allow the project to scale, and the team behind Synthetix are currently planning how best to action the transition; staking on Synthetix however is now live on L2 mainnet of Optimistic Ethereum.

The project functions through a Synthetix Improvement Proposal (SIP) process that enables anyone in the Synthetix community to put forward improvement proposals related to the protocol. These could include core protocol specifications, client APIs, and contract standards, and it is unclear yet whether the move to L2 will to be included within the SIP or each transition phase should be its own SIP.

Synthetics are undoubtedly playing a key role in the expansion and overall adoption of DeFi protocols and products. As the appetite for decentralization grows, these solutions will only become more popular and it will be interesting to see which become the go-to platforms for the next generations of DeFi users.

Whether it is to unlock new financial tools for the world’s unbanked, to normalise decentralized trading platforms for wall street traders or to offer alternatives to DeFi projects that want to build sustainable and active economies, synthetic assets are here to stay and the future landscape looks exciting indeed.

What are your favourite synthetic projects in DeFi right now? Hit me up on Twitter and let me know!