One of the most fascinating financial innovations to emerge in the DeFi ecosystem in recent years are synthetic assets – digital representations of real-world assets such as fiat currencies, commodities, equities or any other kind of assets (including other cryptocurrencies). Such synthetic assets can be created on the blockchain and have the power to revolutionise financial markets, making them more liquid, more accessible and a true equaliser to global finance. This article is about synthetic assets in DeFi and what they could mean for the future.
Understanding Synthetic Assets
Synthetic assets are financial instruments that track the value of an underlying asset, such as a stock share or piece of property, even though they are traded on blockchain networks. Such exposure is made possible by smart contracts and various collateralisation mechanisms. Users can gain exposure to any asset distributed throughout the world without having to own the underlying asset – an Apple share, a house, a part of a cargo flight, a barrel of South American coffee, the price of gold – the list seemingly goes on.
The Role of Synthetic Assets in DeFi
In DeFi schemas, synthetic assets are particularly useful in that they help to make investment more accessible, removing barriers to participation that previously existed in certain markets. For example, investing in foreign stocks and currencies used to require jumping through certain legal, geographical or financial hoops. The barrier to investment included the cost of engaging a third party to trade these financial instruments. By providing simulation of foreign asset ownership, synthetic assets open up these markets to any and all comers.
Besides providing access to real‐world financial assets, they also inject a certain fluidity into DeFi; since they are tokenised, these assets can be freely traded on decentralised exchanges (DEXs) which bypass any need for traditional gatekeepers, thereby dramatically reducing trading speed and costs, and making financial systems more efficient.
Benefits of Synthetic Assets in DeFi
The introduction of synthetic assets to DeFi achieves several goals, including effective price discovery mechanisms, devoid of the traditional market manipulation; and portfolio diversification, as investors can diversify their risk across a portfolio of assets.
And a great advantage is to be able to trade 24/7 The second is that DeFi allows for nonstop trading, while traditional financial markets have ‘open’ and ‘close’ trading hours (with varying degrees of activity in between), so DeFi markets never close and should allow for more dynamic, hour-to-hour price changes.
Challenges and Risks
Courtesy NFT marketplace Async PioneersDespite all that, synthetic assets are still in their infancy, and have existed only since early 2020. The potential impact could be tremendous, but there are still some important hurdles to clear. The first concern is the dependence on the oracles, the price feeds that currently source the prices of the tokenised assets. If the oracle system itself is compromised somehow, then it’s a disaster. Secondly, though DeFi is permissionless today, and there is a concerted effort to make it so tomorrow, current regulation is still moving forward, and the integration of synthetic assets could be a flashpoint for disruption that regulators want to avoid.
Beyond that, the systemic difficulties in grasping – let alone accounting for – synthetic assets could be an issue for some investors. Those new to DeFi will especially be challenged with ferreting out the best risks and exchanges, and education and user-friendly interfaces will be vital in bridging this experience gap.
Future Prospects
While uncertain, the potential of synthetic assets in DeFi appears bright and will be determined by the success of technological advancements, regulatory frameworks and the wider acceptance of DeFi practices. As the DeFi ecosystem matures and more secure and scalable solutions are developed, synthetic assets are bound to see enhanced adoption.
Furthermore, the rapidly improving functionality and reliability of synthetic assets provided by blockchain technology and smart contracts seems likely to draw further institutional interest and broaden demand in traditional markets.
As a concussion, in conclusion, synthetic assets are a clear development in financial inclusion and efficiency on a global scale. The obstacles are prevalent and though they need to be worked on, the manifest advantages that this creation of synthetic assets in the DeFi sphere will bring about are momentous and profound and mark a whole new direction for finance.
