SNX is growing rapidly, this article analyzes the DeFi innovation behind Synthetix

Author: THOR HARTVIGSEN

Compilation of the original text: Deep Tide TechFlow

Synthetix has seen significant growth recently. This article aims to dissect what makes Synthetix unique right now, how it has performed recently and why V3 is a major innovation for DeFi.

Current state of Synthetix

Synthetix was launched in 2017 by Kain Warwick and Justin Moses. Originally known as Havven, the project offers a stablecoin (nUSD) overcollateralized by crypto assets. The protocol has grown considerably since then, and now offers a synthetic form of the asset on the Ethereum mainnet and Optimism.

Today, Synthetix acts as a liquidity layer for many DeFi protocols. On Synthetix, users stake the native token SNX to mint sUSD (synthetic USD). Thus, sUSD is Synthetix's native stablecoin, over-collateralized by SNX, and represents users' debt on the protocol.

Therefore, the total available liquidity that protocols built on top of Synthetix can use depends on the amount of collateral (i.e. SNX) on the protocol. Why should users stake SNX to achieve this synthetic liquidity? Because stakers are rewarded in native SNX tokens and also receive fees for leveraging this synthetic debt (currently 40% annualized). If the number of SNX staked is below a certain threshold, the issuance of SNX will be increased, thereby attracting more users to stake SNX and increasing liquidity.

Liquidity on Synthetix supports two different types of assets: spot and futures. Spot Synthetics tracks various assets such as cryptocurrencies, commodities, foreign exchange and more. This is a way for users to acquire their underlying asset without actually holding that asset. Synthetic futures allow users to trade leveraged futures on various assets. Liquidity on Synthetix acts as the counterparty to these trades. Therefore, SNX stakers bear counterparty risk. This means that if a trader on a trading protocol utilizing Synthetix liquidity (eg Kwenta) makes huge profits, the staker's debt will increase, and vice versa. However, there are mechanisms to reduce this risk, including providing traders with arbitrage opportunities (funding rates) when trading activity deviates. This is intended to make liquidity providers (SNX stakers) hedge-neutral, whereas V3 will introduce segregated risk.

Account

As of now, Synthetix has a Total Value Locked (TVL) of $375 million, meaning $375 million worth of SNX has been staked. An example of liquidity built on top of Synthetix and leveraging the protocol is Kwenta. Kwenta is a perpetual futures trading protocol on Optimism. It has no native liquidity, but inherits liquidity from Synthetix. All trading pairs on Kwenta are denominated in sUSD, so in order to trade these synthetic assets, users need to mint sUSD by staking SNX (or buying sUSD on the market).

All transaction fees incurred on Kwenta are paid to SNX stakers. On average, Kwenta captures approximately 60-70% of all fees incurred by protocols utilizing Synthetix's liquidity. There are other protocols/frontends built on top of Synthetix, including:

Lyra;

Thales;

Account;

dHedge;

Polynomial.

Infinex

Infinex is an on-chain perpetual exchange that aims to simulate the trading experience on a centralized exchange on-chain in a decentralized manner. Since the user interface and experience are at the heart of the protocol, there will be a "simple" and "pro" mode to make it easier to attract new traders.

The protocol will not have a new native token, but will be governed by SNX. Additionally, all proceeds will be used to deepen liquidity on Synthetix by purchasing and staking SNX. The greater the trading volume, the greater the buying pressure on SNX and the deeper the liquidity. This can form a virtuous cycle.

Synthetix V2 metrics

Below is a chart from Token Terminal showing the price of SNX and the volume traded using Synthetix liquidity. As the chart shows, there is a large divergence between recent on-chain activity and the current price of SNX.

Synthetix has launched a number of products recently, with the Perps V2 upgrade playing a major role in increasing activity. The upgrade introduces various synthetic assets, available on protocols such as Kwenta. It’s worth mentioning that Synthetix received a large amount of OP tokens from Optimism, which are used in protocols like Kwenta to incentivize users to use the product. In addition, Kwenta issues additional KWENTA tokens to provide higher incentives.

Below is a graph of TVL, which in the case of Synthetix is directly correlated to the price of SNX, as shown below. This is because, as mentioned earlier, SNX is the only asset that can be staked on the protocol.

Synthetix is the core infrastructure in DeFi, and its liquidity is used by multiple protocols, as mentioned above. Currently, liquidity or TVL is limited in that only SNX can be staked on Synthetix. This will change in V3.

Synthetix V3

Synthetix V3 includes a series of upgrades that take Synthetix to the next level: providing a cross-chain liquidity layer for DeFi. V3 is currently in alpha stage, and different features will be rolled out gradually.

TLDR

Multi-collateral, not just SNX;

A permissionless liquidity layer;

Developer-friendly ecosystem;

Seamless cross-chain implementation.

Multi-Collateral Staking

Multi-collateral staking is one of the core tenets of the Synthetix V3 vision. Currently, only SNX can be staked to provide the liquidity used by the synthetic spot and perpetual markets. V3 introduces a vault design, where each vault is represented by a collateral (token). One vault could be ETH, another SNX, and a third wBTC. The types of collateral that make up these vaults are added through governance. Additionally, vaults can be added to pools for use by protocols wishing to leverage specific liquidity. For example, a pool could consist of an ETH vault and a DAI vault, which could then be available on an on-chain derivatives market such as Kwenta. Some of these benefits include:

As a staker, you can choose which assets to provide as collateral, and get income and enjoy more freedom.

Since the pool is tied to a specific market, stakers can avoid risk. Risk-averse investors may only provide liquidity to the pools used by the BTC and ETH markets, and not riskier assets.

Since the pool is tied to a specific market, it can be better hedged, reducing counterparty risk.

Permissionless Liquidity Layer

With V3, developers can create new markets on Synthetix that leverage liquidity pools in a permissionless manner. A significant hurdle in DeFi is building liquidity early on, often incentivized through massive token issuance.

In addition to being able to choose which liquidity pools the marketplace should integrate, marketplace creators can also choose which oracles to use for their products and create custom reward structures for liquidity providers. The listing of new synthetic assets is also no longer done through governance, but can be easily achieved. These assets can be anything from spot OPs to ETH options.

Synthetix will ultimately act as a liquidity-as-a-service platform that can be easily integrated by new products.

Seamless cross-chain implementation

The ultimate goal of Synthetix V3 is to be available on any EVM chain. So-called Teleporters will make liquidity provided on one chain available on other chains. For example, if users provide liquidity to Optimism's pools, markets on Arbitrum can leverage that liquidity to support their platform.

Here is an overview of the structure of the Synthetix V3 spot market: users deposit their assets into vaults, which are added to specific pools. These pools can be used by protocols to create markets on top of Synthetix liquidity pools. These marketplaces are where users interact on dapps built on Synthetix such as Kwenta.

Path to V3

The following is a brief introduction to the plan before the release of the full version of Synthetix V3:

Stablecoin Migration - V3 introduces a new synthetic stablecoin to replace the current V2 sUSD. A name has yet to be decided, but one suggestion is to keep the new stablecoin as "sUSD" and then rename the current V2 version to "oldUSD" or "legacyUSD". Over time, as new V3 stablecoins and synthetic assets gain liquidity and empowerment, users will need to migrate their assets from V2 to V3 (via the Curve pool).

Perps V3 - Perps V3 will introduce the aforementioned multi-collateral. Most importantly for traders on protocols like Kwenta, Polynomial, etc., all synthetic assets (not just sUSD) can be used as collateral for transactions. The UI/UX will also be more streamlined and intuitive. Most of the core code has been completed and is close to being audited. The testnet may go live in late July.

Upgrade V2 SNX stakers to V3 LPs - This feature allows current SNX stakers to migrate to V3 without paying down debt and closing positions. (SIP-306).

Teleporters - Teleporters are a key part of V3's cross-chain functionality. To enable cross-chain liquidity usage, they burn sUSD on one chain and mint sUSD on another, eliminating slippage and the need for cross-chain bridges. Teleporters is currently under development and running on several testnets. (SIP-311).

Cross-chain pool synthesis - This is another core aspect needed to realize the vision of full-chain liquidity. It enables markets and pools to understand the state of other on-chain collateral. With this functionality, new perpetual markets can be launched on one chain and leverage liquidity on another. Currently working on testnet (SIP-312).

Conclusion

The ultimate goal of Synthetix is very exciting, but the key is to create demand and attract developers to build solutions that utilize Synthetix as a liquidity layer. The more protocols (such as Kwenta) are built on Synthetix, the higher the yield will be for liquidity providers (stakers on Synthetix). As yields increase, so does the liquidity offered, and deeper liquidity will attract more protocols to build on top of Synthetix. This is a virtuous circle of mutual promotion.

As mentioned earlier, 60-70% of the fees earned by SNX stakers come from traders on Kwenta alone. Transactions on Kwenta are strongly incentivized by the emission of large amounts of OP and KWENTA tokens, so it is difficult to estimate the extent of recent user growth.