Synthetic Tokens: Definition and characteristics.

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Synthetic tokens are used to replicate exposure to an underlying asset without having to own the physical asset itself. For example, a synthetic token could replicate the price of gold or oil, without the investor having to own the physical asset. This allows investors to access a wide range of assets and markets, without the limitations they may have when acquiring and storing the physical asset.

To create a synthetic token, a smart contract is used that contains information about the price of the underlying asset and the parameters necessary to create and issue the synthetic token. Once the token has been created, it can be traded on a blockchain network, allowing investors to buy and sell these synthetic tokens similar to any other digital asset.

One of the most popular synthetic token protocols is Synthetix, developed on the Ethereum network.

On Synthetix, you can buy synthetic tokens, called Synths, of different assets whose prices are defined by decentralized oracles. That is, it allows you to be exposed to the prices of an asset without directly owning it. Some of the synthetic tokens you can acquire on Synthetix are:

• Cryptocurrencies: Such as sBTC, sETH, or sMATIC, among others.
• Forex: Such as sUSD or sEUR, among others.
• Commodities: Such as sXAU, which is a synthetic of gold.

One of the advantages of these synthetic tokens, as they are ERC-20 tokens on Ethereum, is that they can be easily integrated by other DeFi protocols. For example, Synths can be deposited in protocols like Uniswap, Sushi, or Curve, to provide liquidity and earn trading fees just like other ERC-20 tokens.

Tokens backed by real assets

Some media and users consider tokens backed by real assets to also be synthetic tokens. However, even though you are not directly purchasing the asset, this type of tokens does have the asset in reserve, so they should not be considered 100% synthetic tokens.

Within this type of tokens, you will find, for example:

• Stablecoins or stable coins, which are coins that replicate the price of a fiat currency. For example, the most famous stable coins such as USDT, USDC or BUSD that replicate the price of the dollar or EURC that replicates the price of the euro.
• Non-native tokens of other blockchains, such as a bitcoin (BTC) token on the Ethereum network.
• Commodities, such as PAX Gold, which is an ERC-20 token on the Ethereum network that replicates the price of gold, but is backed by real gold reserves.

Advantages and disadvantages of synthetic tokens

The advantages of synthetic tokens are:

• Access to a wide range of assets and markets: Synthetic tokens allow investors to access a wide variety of assets and markets without needing to own the underlying physical asset.
• Risk hedging tool: Synthetic tokens can be used as a risk hedging tool in financial markets, allowing investors to reduce their exposure to market risks.
• User-friendly: Synthetic tokens can be traded on a blockchain network, enabling investors to buy and sell these tokens easily and conveniently.

However, there are also disadvantages to using synthetic tokens, such as:

• Security risks: Since synthetic tokens are created using smart contracts, there is a risk that the contract code may have errors or vulnerabilities, which could compromise the token's security.
• Dependence on the underlying asset: The value of a synthetic token is linked to the price of the underlying asset, so investors are also exposed to the market risks of the underlying asset.
• Uncertain regulation: Although synthetic tokens are gaining popularity, the regulation surrounding them is still uncertain, which can create uncertainty regarding their use and adoption.

In summary, synthetic tokens are a way to represent financial assets on the blockchain without needing to own the physical asset itself. They are used to replicate exposure to an underlying asset and can be a risk hedging tool for investors. However, they also present risks and limitations that should be taken into account before investing in them.