Synthetix Deep Dive
A look into how Synthetix works and the differences it has to Metronome
Overview
- What is Synthetix?
- How Does Synthetix Work?
- What is Kwenta?
- The Differences Between Synthetix and Metronome
- Summary
What is Synthetix?
Synthetix is a decentralized liquidity provisioning protocol, designed for generating synthetic assets, currently launched on Ethereum and Optimism. As you may already know, these assets mirror derivatives in TradFi and can function similarly on-chain through the use of smart contracts and oracles.
The variety of synths you can trade on Synthetix is quite wide, ranging from cryptocurrencies to indexes, inverses, and even tangible commodities like gold. These trades often occur on Kwenta, the proprietary decentralized exchange of Synthetix. Critical to all of this is its native Synthetix Network Token (SNX), serving as collateral, supporting the synths that are issued, and ensuring a stable and reliable ecosystem.
How Does Synthetix Work?
The intricacies of Synthetix start making sense once we understand the concept of decentralized oracles, a key part in the creation of synthetic assets. These oracles are price discovery protocols built into smart contracts that track off-chain assets’ prices, making the data readable on-chain. The beauty of this is that it enables you to gain exposure to assets, like gold, without physically holding them.
While this may sound similar to other tokenized commodities, synths are unique in that you don’t actually own the underlying asset. Here’s how it works: you put up collateral to mint a synthetic asset, like sUSD. Though you don’t technically own any USD, you gain exposure to its price, which gives you flexible trading options.
Now, a key benefit to Synthetix being deployed on both Ethereum and Optimism is the opportunity to deposit EVM-compatible synths on other platforms like Curve. This enables you to trade them for other assets, not just limited to synths. Furthermore, you can utilize these synths to provide liquidity and start earning rewards, such as CRV.
So how do you get started? Trading Synths on Synthetix can be initiated in two ways:
- You can exchange your ETH for sUSD on Kwenta, and then use that sUSD to swap for other synths.
- Alternatively, you can acquire SNX tokens, stake them using Mintr — Synthetix’s staking app — and generate synths, which can then be traded on Kwenta.
It’s important to remember that each synth created via staking SNX tokens has a collateralization ratio — a dynamic variable that changes based on the staked SNX value and active debt.
By staking your SNX and creating sUSD, you’re essentially borrowing against your staked tokens. To reclaim your SNX tokens, you need to repay this borrowed amount first. The total debt in the Synthetix system fluctuates based on the supply of synths and their corresponding exchange rates. Given this structure, there’s no requirement for a third party to facilitate trades, thus removing the issues of slippage, counterparty risks, and ensuring sufficient liquidity for trading.
Alongside the collateralization ratio comes a target ratio (currently 500%), a number set by community governance, which if upheld brings potential rewards. Stakers are required to manually manage this ratio by minting sUSD if it is too high, and burning sUSD if it is too low.
These rewards come in two distinct forms:
- SNX tokens for staking rewards.
- sUSD for exchange fees from all synth transactions.
The distribution of these exchange fees is directly connected to the amount of debt each staker has issued. By tying rewards to the collateralization ratio, Synthetix can ensure effective management of the synth-to-collateral balance.
However, unstaking your tokens can sometimes come with a cost, where you might find yourself needing to burn more (or less) sUSD than initially anticipated. The root cause lies in the fluctuating nature of the debt pool and the exact amount will ultimately come down to when you decide to unstake.
What is Kwenta?
Kwenta is Synthetix’s decentralized exchange that enables the trading of an expanding list of assets and derivatives, including spot and futures. Kwenta utilizes peer-to-peer trading via smart contracts, in contrast to conventional models. As mentioned earlier, in order to price assets accurately, Kwenta uses oracles to serve as the information bridge, pulling price feeds from off-chain data sources and placing them on-chain to ensure fair rates.
When you exchange synthetic assets on Kwenta, a transaction fee is taken by Synthetix. These collected fees are directed towards a fee pool that benefits SNX stakers.
Here’s the rundown on the fees:
Keeper Deposit: A standard fee of $2 is allocated to automated ‘keeper’ bots that execute trades. If a keeper bot isn’t available and you execute the trade yourself, this fee is refunded to you.
Maker/Taker Fees: The fees charged for ‘Maker’ and ‘Taker’ actions can vary based on the selected market. The most current fee rates are clearly shown on the Kwenta platform itself.
The Differences Between Synthetix and Metronome
Now that we’ve delved into what Synthetix is, you might notice some similarities with Metronome. Indeed, both platforms contribute to the growth of the synthetic ecosystem. However, it’s crucial to understand that they are distinct in several key aspects, including their product offerings, risk profiles, and how they handle the pricing of swaps.
Firstly, the fee structures of Synthetix and Metronome differ quite significantly. Synthetix uses a dynamic fee structure, while Metronome opted more for a fixed fee.
Now, why does this matter? In simple terms, dynamic fees adapt to market conditions to deter front-running, which can be beneficial for the overall protocol. However, this also means that the fees can fluctuate — you might end up paying significantly more one time than another depending on the market’s behavior.
Metronome, in contrast, uses a fixed fee. All this really means is regardless of the market’s volatility, the fee remains constant. This stability proves particularly beneficial during turbulent market conditions as it provides certainty amidst market instability. For instance, you could take on multiplied exposure to Lido’s wstETH without being affected by fluctuations in the market’s utilization rate.
As mentioned above, Synthetix uses its own token, SNX, as collateral. While this can help ensure every synth minted has a proper backing, it can be a pitfall in terms of capital efficiency for the user. Metronome separates itself by enabling users to deposit multiple forms of collateral, including yield-bearing collateral such as Liquid Staking Tokens (LSTs) and Vesper Pool share tokens, which act as a singular source of collateral value that users can then mint a variety of synthetic assets from. This gives users a much wider variety of options, while simultaneously further increasing the capital efficiency of assets.
Perhaps even more notably, Synthetix uses a variable rate pricing model. Kind of like their dynamic fee structure, the price of Synthetix assets can change with the market conditions. While it does mean potentially higher returns, it’s also a bit more of a gamble, because the price changes could mean losses if the underlying asset goes down.
Metronome takes a different approach, using an open market peg to determine the price of its assets. The price of each synthetic asset is set equal to the price of the asset it’s tracking. For instance, the price of msUSD is equivalent to the price of USD. This method is designed to offer stability and predictability. It also simplifies the process for users trying to calculate the value of their holdings.
Summary
Synthetix and Metronome offer unique approaches in the realm of synthetic assets. Synthetix enables the minting of synths through SNX staking and trading on its proprietary platform, Kwenta. Trading fees serve as rewards, but unstaking can involve unpredictable costs due to a fluctuating debt pool.
On the other hand, Metronome offers more stability with a fixed fee structure and a more versatile range of collateral options, which can provide a shield against market volatility. It also uses an open market peg for pricing, providing predictability and stability to users. Ultimately, choosing which to use will come to a user’s own risk tolerance and how efficient you want your capital to be.
