What's wrong with the hit Synthetix?

The coinage process is as follows:

1.Alice purchased Synthetix's native asset SNX.

2.Alice stores SNX into the Mintr[1] platform.

3.Alice must guarantee a 500% mortgage ratio between the value of her SNX tokens and the synthetic assets she hopes to create.

4. If Alice's collateral is worth $500, she can forge 100 Synthetic ones

USD tokens which are traded under the sUSD symbol. By casting sUSD, Alice is essentially taking on debt and shorting sUSD.

5.Alice can use these susds to purchase another synthetic asset, such as sBTC, through the Synthetix exchange platform.

6. SUSD does not match with the trading party, but converts sUSD into sBTC according to the current exchange rate and destroys it in time. After the conversion, the value of the assets in circulation remains unchanged.

7. In order to recover SNX's collateral, Alice must repay her original sUSD loan. These susds are removed from the system by destruction.

8. If Alice's collateral is worth less than the sUSD she originally minted, she can purchase additional susds on the secondary market and use them to recover her original SNX tokens. Currently all KuCoin, Bittrex, and Uniswap transactions support sUSD.

incentives

The stability of Synthetix's economy is sustained by a series of incentives. The ultimate goal of any synthetic issuance platform is to ensure that the value of the collateral is always equal to or greater than the value of the synthetic assets in circulation. If the value of the collateral is less than the value of the synthetic assets in circulation, the synthetic assets will trade at less than the tracking price because their full value cannot be redeemed as collateral.

Users who deposit SNX as collateral for casting tokens will receive a pro-rated 0.3 per cent of all Synthetix transactions based on the percentage of the composite they cast. Upon receipt, these fees are automatically converted to XRD[2] (Synthetic Drawing Rights), a basket of reserve assets made up of Synthetic currency, which is paid out weekly for up to six weeks. Unclaimed fees will be transferred to the next fee pool.

The reward distribution is dynamically adjusted according to the maintained collateral ratio:

If the user adjusts the collateral ratio to more than 5:1 before applying for the reward, there is no reduction in fees

。

Synthetic issuers only want fees, not leverage, to hedge their risk to a market-neutral position. For example, if Alice casts sUSD and buys ETH, she is shorting sUSD -- she wants the value of sUSD to go down, or in other words, the value of ETH to go up, so she can pay off her debt at a discount. However, she can counteract this short-term risk by shorting ETH, either through Synthetix's own reverse ETH product (iETH), or by borrowing ETH through a secondary lending platform and selling it in dollars, such as Compound or dYdX.

It is these rewards, or dividends, that drive SNX's value and allow it to pledge the system. Again and again, the higher the value of SNX, the more synthetic assets can be released; The more synthetic assets are issued, the greater the volume; The higher the volume, the higher the SNX value.

The reflexive relationship works both ways. If Synthetix's trading volume falls, so will SNX's value. In an efficient market, this would have a knock-on effect, with the mortgage ratio on outstanding assets in Synthetix's ecosystem falling.

In order to further incentivize the issuance of synthetic assets, the agreement adopts an active issuance plan [3], whereby newly issued SNX is placed on a pro-rata basis with companies that use SNX as platform collateral.

To ensure that these inflationary rewards are not sold in the market, SNX earned through collateral is not transferable during the first year of issuance.

Liquidate or sell

Synthetix chooses to use the "carrot" incentive instead of a hybrid model of "carrot" and "stick" like MakerDAO and UMA. When the collateral falls below a certain threshold, there is no clearing process or penalty. Instead, synthetic issuers should maintain their margin requirements by waiving platform transaction fees.

In the absence of a liquidation process, with highly illiquid tokens as collateral, the system would face the unique risk that the price of SNX would collapse and the value of outstanding debt would exceed the value of the collateral. If SNX issuers have sold their sUSD through Uniswap or Bittrex in exchange for other cryptography assets, such as ETH, they have no incentive to provide collateral for the system.

Consider the following scenario:

1.Alice has locked 1000SNX, which is worth $500, and forged sUSD, which is worth $100.

2. Then Alice USES sUSD to buy $100 ETH on Uniswap.

3.SNX prices have fallen 80% -- Alice's SNX collateral is now worth only $100.

4. In order to recover her $100 SNX collateral, Alice must repay $100 worth of sUSD.

In the example above, Alice has two choices. She can either keep the $100 ETH or sell the $100 ETH to recover the $100 SNX. This is to some extent equivalent to the "free option" [4] problem in the state channel.

Due to ETH's relative liquidity issues with SNX, Alice will choose to hold her $100 ETH, which means the system will remain below its target mortgage ratio. If SNX's price recovers and the current value far exceeds the $100 ETH, Alice can repay her debt and get her collateral back.

Of course, Alice has lost a lot of money on transaction fee returns by failing to top up the collateral, but it is difficult to accurately estimate the value of the collateral, and given that the system is undercollateralized, the user seems to have little interest in the transaction.

Since exchange fees are paid on a weekly basis, which can be claimed up to every six weeks, and there is no penalty for claiming fees while maintaining the mortgage ratio, this system is incompatible with incentives. The system can be severely short of collateral for weeks on end, with issuers regularly replenishing the collateral.

Without the liquidation process, it is difficult to understand what role SNX plays in the system. MakerDAO USES an "emergency shutdown" feature, where all collateral is liquidated when the system falls below a certain mortgage rate, and the person holding DAI gets the equivalent of $1 in the ETH. Synthetix, by contrast, does not have the same exchange guarantee: only those locked up by SNX can redeem their synthetic assets.

The introduction of a preliminary clearing process and an "emergency settlement" feature will greatly enhance Synthetix's model. In the liquidation process, a third party can destroy SNX at a discount if the collateral ratio falls below a certain threshold. Alice will be motivated to ensure that her mortgage ratio is above the required threshold, because the value of her loss in the collateral will always be greater than the value of her debt. In the black swan event of a collapse in SNX value, the "emergency settlement" process would ensure that holders of synthetic assets could redeem the assets in full.

SNX

Using SNX as collateral is not an ideal design option, although the Synthetix team recently announced that they would allow SNX holders to hold up to 200% of their positions in ETH.

Using SNX as collateral involves three risks.

First, the SNX market is very short of capital liquidity and prone to sharp price declines. Uniswap SNX/ETH is currently the most liquid location for SNX traders. With ETH priced at $245, the current price in the SNX liquidity pool is more than $575,000. Constant product structure results in the following table:

Even with a robust clearing system, the lack of liquidity in the SNX market suggests that it is difficult to recover value without collateral. A million SNX sold on Uniswap, equal to 1 per cent of the total supply, is enough to wipe out 60 per cent of the network value and immediately result in a shortage of Synthetix systems: it is likely that a small order would do as much damage to a standard order transaction.

Weak market liquidity can be a two-way street. As the CLAM on Poloniex recently demonstrated, the price of SNX can be manipulated to produce a large amount of sUSD, which can then be exchanged for more liquid tokens like ETH. At the same time, these susds should actually be trading at a substantial discount to the dollar when calculating the actual value of the collateral.

The second drawback of using illiquid SNX as collateral is that collateral requirements must be set at unprecedented levels. Makerdao USES a 150% mortgage ratio, which may prove too conservative: by early February, the median CDPs mortgage at liquidation was 149.5%. With loan agreements offering high lending rates and inventory risk, a 500% mortgage ratio comes with a significant opportunity cost: there are still questions about whether the exchange rate can exceed DAI's current risk-free rate of 7.86%.

A third drawback to using SNX as collateral is that the value of the synthetic assets issued and the system's ability to scale are essentially constrained by SNX's market value.

With a network value of about $30m, the system can currently handle up to $6m in synthetic asset issues. As mentioned earlier, there is a reflexive relationship between the fundamental value of SNX and the volume of composite transactions: in order for SNX to be valuable and continue to appreciate, there must be an increasing volume of transactions. This is hard to achieve in such an inefficient capital system.

Predicting machine

There are more issues with the Synthetix oracle design that need to be addressed. While the proprietary Synthetix exchange will exchange at par, there is no mechanism for synthetic assets to be traded on the secondary market at target levels. SUSD is currently trading at 97 cents on Uniswap, compared with 89 cents last week.

MakerDAO USES interest rates to influence the behavior of CDP holders: trading below their fixed interest rate is increased when DAI trading is low, and the increased cost of debt triggers DAI disruption and reduces outstanding supply.

Instead, interest rates fall when DAI trades below $1: cheap debt encourages new DAI, increases the supply of outstanding DAI and depreciates DAI prices. Without these interest rate mechanisms, the Synthetix system cannot restore supply and demand for synthetic assets to equilibrium.

Given the risks associated with the protocol design, it is conceivable that synthetic assets published through Synthetix will always trade at a discount.

A predictive mechanism to maintain flexible prices is necessary for any synthetic issuance platform - the system must always know the value of the assets outstanding and the collateral supporting them.

The Synthetix team currently controls all oracle and plans to migrate to Chainlink products in the near future. SNX price oracle does not appear to take liquidity into account and instead USES the final trading price of Uniswap. As the table above shows, this can be problematic when prices for large orders fall.

The future of Synthetix

At this point, Synthetix's appeal is clear: the rich platform user experience is good and easy to use compared to many DeFi products. SNX is one of the few tokens on the market that focuses on core product growth, and the cryptocurrency ecosystem is beginning to recognize the great potential of synthesizing products with the ability to withstand censorship.

However, the decision to avoid the liquidation process while creating proprietary tokens as collateral was not ideal. The former is particularly confusing because there is no liquidation process; The latter may be the result of a need to reassure ICO investors.

If Synthetix is to succeed in the next few years, it will have to integrate liquidation processes, types of collateral with more liquidity and some monetary policy tool. This may be hard for existing SNX holders to swallow, as they face the risk of clearing, but without the need for exchange guarantees for these synthetic products and the volume of trading on Synthetix, they could be in trouble.