How are Synthetic Assets Created?
Synthetic assets, often referred to as "synths", are digital representations of real-world assets created through decentralized finance (DeFi) protocols. They enable users to gain exposure to the price movement of various underlying assets without owning the actual asset. The creation of synthetic assets involves several key steps:
1. Collateralization
To create a synthetic asset, users must first lock up a certain amount of cryptocurrency as collateral. This collateral serves as a security mechanism, ensuring that the synthetic asset has value and that users cannot default on their obligations. The collateralization ratio typically varies based on the protocol and the volatility of the underlying asset.
2. Minting Process
Once the collateral is locked, users can then mint the synthetic asset through a smart contract. The smart contract encodes the rules governing the synthetic asset and ensures that its value reflects that of the underlying asset it represents. This process is often facilitated by platforms like Synthetix or Mirror.
3. Price Feeds and Oracles
To maintain accurate pricing, DeFi platforms utilizing synthetic assets rely on decentralized oracles to provide real-time data about the underlying asset’s price. These oracles fetch price data from various sources and ensure that the synthetic asset's value remains in sync with the actual market conditions.
4. Trading and Liquidity
Once minted, synthetic assets can be traded on decentralized exchanges (DEXs) or held in users' wallets. Liquidity is crucial for the functioning of synthetic assets, as it enables users to enter and exit positions easily.
Overall, synthetic assets democratize access to various markets and investment opportunities while providing additional layers of security and flexibility in the DeFi ecosystem.