If synths are not backed by any underlying asset, what are they backed by then?

Synths should not be confused with other digital assets that are backed by real assets. For example, sXAU synth, which represents gold, is a blockchain-based derivative. sXAU is simply a tokenized financial contract that offers exposure to the price of gold.

For example, the Synthetix protocol works with over-hedging, which means that each synthetic asset is collateralized with more value than it represents. Specifically, the Synthetix system of operation requires hedging at a rate of 750 %. If a user wants to mint sUSD 1,000, they must deposit 7 500 USD.

What are the benefits of synthetic assets?

Synthetic assets:

• are designed to provide an almost infinite amount of liquidity
• can be exchanged without the need for a counterparty
• can take any form; they are designed with an "s" prefix
• are blockchain assets, such as ERC-20 tokens. Sending and receiving them is easy and can be done through standard cryptocurrency wallets.
• can be issued by anyone through designated protocols
• offer the option to switch between shares, synthetic silver / gold and other assets without having to hold the underlying asset
• provide far greater liquidity on global exchanges, in swap protocols and wallets than traditional derivatives are capable of

Disadvantages of synthetic assets

• Incorrect data from oracles can affect the entire operation of the synthetic asset protocol. If the oracle conveys incorrect information, whether due to innocent mistakes or deliberate actions, it can end up in the loss of digital assets for investors who expected true data.
• Need for third party involvement. Oracles are never built directly into the blockchain. The process requires a third-party involvement.
• Risks associated with smart contracts that can be attacked by hackers. Contract security is improving through better code verification and third-party audits, but hacks are still common in DeFi despite this verification.
• Risks associated with possible cryptocurrency regulations

Conclusion

Synths track the price of the underlying asset without requiring the user to own the asset itself. Synthetic asset technology has the potential to create a tokenized market of digitized real-world assets on the blockchain. Let us watch, and be astonished at what the future of this sector will bring.

Personal Opinion

Synthetic assets have made sure that it is now possible to tokenize and trade almost anything in the real world. A synthetic asset does not have to be just an asset like stocks, or shares in a company; it can be anything you could imagine storing and transferring on the blockchain. By enabling synthetic assets to put anything into a tokenized form and onto the blockchain, this technology is unlocking access to vast pools of global liquidity. In short, synthetic assets create many new possibilities for future businesses to operate globally utilizing the blockchain.
However, this technology is still in its infancy. Despite the great shift that synthetic assets can bring to the future of the technology, they still reveal some drawbacks,whether those are possible problems stemming from inaccurate Oracle data that the synths depend on, or a possible smart contract exploitation. Therefore, always remember to diversify your investments sufficiently and DYOR thoroughly before each investment!