Synthetix V3 application prospects and data interpretation

After the bankruptcy of FTX, decentralized derivatives exchanges have seen a significant increase in trading volume and attention. In recent years, with the improvement of L2 and various Appchain open-source architectures, the reliability and concurrency performance of Dex have greatly increased. Dex PERP has become the most profitable category of products in bear markets. As the industry continues to explore decentralization, these types of products will undoubtedly become an important part of the industry going forward.

Currently, the mainstream decentralized derivatives designs on the market mainly include the Orderbook model represented by Dydx, and the peer-to-pool (Pool and Vault) model represented by Snx. Today, Snx has been reconstructed and upgraded from a 17-year-old asset synthesis platform to a modular liquidity protocol, aiming to become a universal liquidity layer for financial products on the chain. New features and improvements are expected to usher in new business increments and valuations. In this article, we will explain Snx V3 with data and application scenarios.

There are two types of core users in the Snx ecosystem

1. Staker
   Stake Snx to receive system inflation rewards and trader’s transaction fees.

2. Trader
   Users who use atomic swap or Perps trading within the Snx protocol

Principle of Synthetic Assets

The principle of pledging stablecoins is to generate tokens equivalent to the US dollar by collateralizing assets. Similarly, users can also collateralize assets and generate tokens that anchor the price trends of stocks, gold, and other assets using price data from oracles.

The Snx ecosystem currently has sUSD anchoring the price of USD, sBTC anchoring the price of Bitcoin, and sETH anchoring the price of Ethereum, etc. They are collectively referred to as Synths synthetic assets.

The entire system’s liabilities are settled in sUSD. The Snx V2 version only allows Staker pledgers to generate sUSD through Mint by staking Snx. The essence is to borrow sUSD by mortgaging Snx. So the minted sUSD is a liability for the user and the entire system.

When the collateralization ratio reaches more than 400% (this ratio will be determined by DAO voting according to market conditions), Snx’s inflation rewards and transaction fee rewards will be obtained. If the collateralization ratio is below 160% and there is no addition of collateral Snx within a 12-hour buffer period, or if the collateralization ratio is not increased to above 400% by repaying the sUSD debt, Stakers may face the risk of liquidation. To unlock the collateral, Stakers need to repay all sUSD debt.

The process of atomic swap

Transactions between Snx synthetic assets are completed through smart contracts that destroy one token and mint another.Therefore, when TVL is satisfied, there will be no slippage except for fluctuations caused by price delays.

The principle of dynamic debt pool

The total value of all Synths assets in the entire system = the total issued debt of the system

If a trader exchanges sUSD for other Synths assets, such as sBTC, the overall debt amount will increase or decrease depending on the corresponding Synths prices. Therefore, the total debt of the entire system is not fixed, hence it is called a dynamic debt pool. The total debt of the entire system is shared proportionally among all Snx collateral holders.Therefore, a Staker who only participates in minting sUSD without any actions will have a dynamically changing debt.。

Case:

Assume that there are only two people in the system, A and B, and they respectively stake Snx and mint 100sUSD. Assume that the current price of btc is 100u. When A purchases sUSD and exchanges it for sBTC, the Snx protocol will destroy 100 sUSD in the debt pool and generate 1 sBTC in the debt pool.

If B has not done anything. As shown in the graph above. When Bitcoin doubles, the debt of both A and B becomes 150 sUSD, but the asset value of A is 200 sUSD, and the asset value of B remains 100 sUSD. At this point, A sells sBTC for 200 sUSD, and only needs 150 sUSD to redeem Snx, while B needs to purchase an additional 50 sUSD to redeem the collateralized Snx.

Therefore, when a trader suffers a loss, his loss will reduce the total value of the global debt pool, thereby reducing the average debt level of all stakers, allowing each staker to benefit equally in proportion, that is, reducing the debt. Vice versa, when a trader makes a profit, the pool liability increases. Each Staker will share the loss equally, that is, he needs to purchase additional sUSD to redeem his Snx.

Snx supports spot atomic exchange and perpetual trading. When the size of the pool is large enough, the impact of a single transaction on the pool will stabilize, and Staker can obtain the transaction fee for each transaction. According to the Kelly formula, Staker will be in profit mode in the long run.

However, if the system is unbalanced between long and short, in extreme situations or unilateral market conditions, Staker may face a situation where others make profits while you lose money. In order to further reduce Staker’s risk, V3 provides more mechanisms to maintain system Delta neutrality.

What Snxv 3 brings

Liquidity as a Service

After two years of reconstruction and development, Synthetix v3 has undergone upgrades and positioned itself as the liquidity layer of decentralized finance. The launch of Synthetix V3 will occur in phases over the next few months. As part of the plan, the existing functions of v2 will become a subset of v3 functions. Once the final version is released, developers will have the ability to create new derivative markets that can directly integrate with the Snx debt pool for liquidity. These markets include perpetual futures, spot, options, insurance, and exotic options. There is no need to start from scratch.

Products currently in the Snx ecosystem

The use cases proposed by Snx are as follows:：

1.Perpetual futures/options/structured products: This feature supports trading of perpetual futures and leveraged positions, including basis trading and funding interest rate arbitrage.
Example: Kwenta and Polynomial exchanges are currently online, and GMX can actually be built on Synthetix v3.

1. NFT-Fi lending/perpetual contracts: Users have the option to borrow synthetic assets anchored to the trend of NFTs or create a market for perpetual contracts that speculate on the future price of NFTs.
   For example, nftperp.xyz can be built on Synthetix v3.
2. Insurance Market: Users have the option to buy insurance contracts for different risks. These contracts are collateralized in a pool and managed by smart contracts.
   For example, Nexus Mutual can be built on Synthetix v3.
3. Prediction Market/Binary Options/Sports Betting: Users can predict the outcome of an event.
   Example: election results or sports matches. Lyra and dhedge are currently online in the Snx ecosystem
4. RWA market: With reliable oracles and trusted entity verification, synthetic assets such as artwork, carbon credits, or other off-chain assets can be developed to be traded on the chain.

New debt pools and collateral

As mentioned above, in Snx’s Pool and Vault mode, Staker needs to temporarily act as Trader’s counter party. The volume of Staker’s debt pool determines the liquidity limit.

Currently, a single collateral may have the following problems:

1. This could result in the maximum open interest of the system being limited by the market value of Snx itself, which means that the liquidity of traders will be restricted.
2. Different synthetic assets have different fluctuations. Staker’s returns and risk rewards may not align.
3. In extreme circumstances, there may be a potential risk of spiral liquidation.

From Kwenta, you can see the total positions currently held by the entire Snx network. In cooperation with the OP to encourage activities, the short and long positions of BTC and ETH have repeatedly approached the system’s capacity limit.

In order to solve the above problems, V3 has launched the following functions

Segregated debt pools

In the existing Synthetix V2, all transactions go through a single Snx debt pool. However, different synthetic assets have different volatilities, risks, and returns. To address this issue, (this article will list relevant cases in the section on anti-Oracle latency attacks).

Synthetix V3 passed the SIP-302: Pools (V3) proposal, allowing Staker to decide for himself which markets to support liquidity based on their own risk appetite. Voting governance can determine the collateral type and upper limit of each pool, even if risks arise , and can also be limited to a small range. At the same time, it also provides Snx stakers with the opportunity to take higher risks and obtain higher returns. This gives stakers more control over their exposure. For example, you can decide to only provide exposure to mainstream assets such as ETH and BTC, and not participate in the market debt pool of long-tail assets such as NFT.

Multiple collateral mechanism

V3 creates a universal collateral vault system that is compatible with multiple collateral types. This means that, in addition to $Snx, Synthetix will support other assets as collateral for Synths to expand the market size of Synths assets.

Voting governance will determine which assets will be supported as collateral in addition to the current Snx. For example, you can vote to allow ETH to also be used as collateral. Eight related proposals, SIP-302~310, have been adopted.

So the new pool and treasury system has three main advantages:

1. Better risk management: pools are linked to specific markets and therefore have specific exposures
2. Better hedging capabilities: The capital pool is connected to a specific market and allows for precise hedging.
3. Wider collateral range: Stakers can pledge any assets the pool chooses to accept, solving the risk of a single asset.

Perps V2 and V3 engines

Perps is a decentralized sustainable engine launched by Snx based on debt pool liquidity.

The beta version of Synthetix Perps V1 was released in March 2022, and without any trading incentives, it generated over $5.2b+ in trading volume and provided Staker with $18.1 million in transaction fees.

The Synthetix Perps V2 plan, launched in December 2022 and the version currently in use, can reduce expenses, improve scalability and capital efficiency.

Isolated Margin

Synthetix Perps V3 is scheduled to be released in the fourth quarter of this year. Synthetix Perps v3 supports all v2x features, plus some new features such as Cross Margin, a new risk management feature designed to eliminate market bias. These include price impact measures and dynamic financing rates.

Founder Kain Warwick said that Synthetix aims to launch the Perps V3 version and its new decentralized perpetual contract exchange front-end Infinex in the fourth quarter of this year.

The team said Infinex will focus on making it easy for users to trade decentralized perpetual contracts. It aims to provide a better user experience compared to other decentralized exchanges, eliminating the cumbersome process that current DEXs require to sign for each transaction.

Maintain Delta Neutral

Perps V2 can effectively match buyers and sellers. Snx stakers only need to act as temporary counterparties and temporarily bear asset risks. Incentives will reward traders to keep the market neutral.

Synthetix incentivizes a balance between long and short open interest in the market through funding fees and discount/premium pricing features. The side of the transaction that is crowded will be charged a funding fee and the other side will receive a funding fee.

In centralized trading platforms, funding fees are usually charged every 8 hours, while in Synthetix funding fees are charged in real time as the position continues. Likewise, a trade that shifts the long-short ratio will be charged a premium, and a trade that balances the long-short ratio will receive a discount.This mechanism allows arbitrage traders to actively arbitrage when deviations occur. Reduce the risk of LP in unilateral market conditions.

Oracle improvement plan

Anti-Oracle latency arbitrage

Oracle Latency Arbitrage is the main reason why the Dex platform was previously unable to compete with centralized exchanges.

In the previous version of Synthetix, Synth relied on the oracle Chainlink to provide prices, but the on-chain price update of the oracle lagged behind the price changes in the spot market. At this time, there was the possibility of preemptive trading. In the context of Synthetix’s slippage-free trading, Snx stakers may face heavy losses. For example, if a user observes that the price of ETH rises from US$1,000 to US$1,010 in a short period of time, but the price quoted by Chainlink is still US$1,000, the user can exchange sUSD for sETH at a price of US$1,000 in Synthetix. After the oracle price is updated, without considering handling fees, each sETH can earn a profit of US$10, and the user’s income comes from the loss of Snx stakers who suffered front-running transactions.

Supplemental Case: Current Strategy Utilized by Snx’s Biggest Competitor, GMX

Source of material:CapitalismLab

Snx currently offers an oracle management mechanism: market creators can choose from multiple oracle solutions and set custom aggregations, giving integrators more control over the oracles that drive the market. The oracle manager provides new opportunities to support new markets and assets.

Example: Select the lowest spot Bitcoin price based on the time-weighted average price (TWAP) of Chainlink, Pyth, and Uniswap.

Synthetix (Snx) also explores two options to solve the oracle latency arbitrage problem.

1. Hindsight oracle solution: A solution proposed by Synthetix in collaboration with the Pyth team. This plan passed asynchronous transactions, configure delay time, reducing the possibility of oracle latency arbitrage. This helps reduce the transaction costs of DeFi platforms, making them more competitive.
2. Chainlink’s low-latency data source: Another solution provided by the Chainlink team for Synthetix. This solution aims to provide a low-latency data source to reduce the opportunity for Oracle latency arbitrage. This solution is superior to the Hindsight Oracle solution in some aspects, such as not relying on a third-party executor (keeper) to complete transactions, thereby reducing transaction costs while protecting the data privacy of data suppliers.

Introduction to the cooperation between Python and Snx:

https://www.youtube.com/watch?v=UAFR4c4-DPk&ab_channel=PythNetwork

Off-chain oracle enables fast on-chain price discovery at a competitive cost. It plays a crucial role in significantly reducing transaction fees. Due to addressing oracle latency arbitrage, the transaction fees for major currency pairs on Synthetix currently range from 0.2% to 0.6%, comparable to advanced VIP users on Binance.

Cross-chain solution

Teleporters - for stablecoins

The SIP-311 proposal proposes the concept of Teleporters. Once Teleporters go online, they can burn newUSD on one chain, transmit cross-chain messages, and mint newUSD on another chain.

• This means that the newUSD stablecoin can be used on any chain deployed by Synthetix, without cross-chain bridges and no transfer slippage.
• Allows liquidity layer to share collateral across all chains
• Quickly move between chains and back from L2 to L1 without challenging verification times.

Cross-chain liquidity pool

Targeting debt pools

• SIP-312 Proposal, enabling all on-chain markets and mining pools to access the current status of all on-chain collateral compositions.
• This means that the Perps market can be quickly deployed to new chains and can leverage the collateral from existing debt pools on Optimism and the Ethereum mainnet.

As mentioned above, through Teleporters and cross-chain liquidity pools, the Synthetix liquidity layer can be extended to any EVM chain, and new chains can directly obtain liquidity support from other chains after they are deployed online.

Economic Model + Revenue Data

The Synthetix protocol generates revenue from various sources. Primarily, through handling fees from the perpetual contract and synthetic asset exchange, as well as perpetual contract and Snx liquidation fees. Additionally, there are handling fees involved in the synthetic asset casting/destruction process. All income generated by the protocol will be distributed in full to integrators and Snx stakers.

Integrator’s revenue distribution

Products developed using the Snx protocol, such as Kwenta, are referred to as integrators.Snx rewards a percentage of fees based on trading volume, and pays in Snx: 10% of fees on the first $1 million, 7.5% on fees between $1 million and $5 million, and 5% on fees > $5 million. Integrators are free to decide how to use these fees, for example, to empower their own platform currency.

The Snx development team is no longer operating the frontend on its own, but instead handing over the specific business to integrators. By adopting an incentive program for integrators, it will enhance network effects and potentially be integrated into more products, becoming an important DeFi component.

User growth

Data as of the publication of this article on July 23. Synthetix’s current TVL, monthly transaction volume and fee income are comparable to competing products GMX, but the total number of daily and monthly active users is far lower than GMX and DYDX.

PerpV2 trading volume

Synthetix Perps has received the Optimism Chain’s liquidity incentive plan this year. Synthetix Perps trading users will receive OP airdrop rewards.

OP incentives started on April 19th, and currently the OP incentives can cover approximately 80% of the handling fees.

According to Messari data, Perps has a strong driving force on transaction volume due to subsidy incentives. The number of user transactions and transaction volume data have grown rapidly.

According to the trend of the number of interactive addresses on the blockchain, there has been an increase in transaction volume figures. However, the number of users has not grown significantly. This suggests that the largest increase in transaction volume is due to an increase in transactions by existing users.

OP’s rewards program will last until September 13th, so it will be easier to understand retention rates after Q3.

Trading user data trends

Data Sources:

https://dune.com/queries/452148/859385?1+Project+Name_t6c1ea=Synthetix&4+End+Date_d83555=2023-06-28+00%3A00%3A00

PE level

As transaction volume increases, income increases and stakers’ income rises. Snx’s PE has returned from the bull market’s 50X to a more reasonable range of 10x-15x.

Weekly fee income data of pledgers

Data Sources:

https://dune.com/synthetix_community/fee-burn

Exploration of new token models

Snx is currently in full circulation, and approximately 5% of the annual inflation rewards are currently provided to Snx stakers.

In August 2022, Synthetix founder Kain Warwick issued proposal SIP-276, suggesting that the issuance of Snx should be set at 300 million and that additional issuance should be stopped after the additional issuance reaches this number. But the proposal has not yet passed.

In June of this year, Kain proposed implementing a new Snx staking module in Synthetix V3. This module will simplify the entire staking process. Users only need to deposit Snx without facing market risks or hedging needs. Initially the Finance Committee will fund the staking pool, but a portion of Synthetix’s protocol fees may also be allocated to the staking pool in the future. Kain emphasized that this simpler staking method is designed to attract more new users to the Synthetix V3 system. The proposal is currently under discussion. It is expected to further increase the Snx staking rate.

Summarize:

In the long term, the decentralized derivatives trading space has immense potential. The launch of Snx V3 is an important milestone for the Synthetix protocol, introducing many new features and improvements. These enhancements can enhance the protocol’s capital efficiency and security, remove liquidity constraints, and improve user experience, attracting more users to participate in the Synthetix protocol. With the full launch of V3, it is expected to bring new business growth and valuation. It is also expected to be integrated into more products and become a crucial component of DeFi.

However, the growth of new users is currently slow, and the development cycle required for the full launch of V3 features is not determined. Under the new token model, the earnings from SNX staking and the retention rate after the third quarter will be important valuation indicators for SNX holders in the short term.

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