Deep Dive into Synthetix V3: Unveiling the Fully Upgraded Functional Modules, Economic Model, and Yield Data

Principle of Synthetic Assets

The principle of staking stablecoins is to generate tokens equivalent to the value of assets through collateral. Similarly, users can also collateralize assets and generate tokens that track the price trends of stocks, gold, etc., using oracle price data.

Currently, the Snx ecosystem includes sUSD, which is pegged to the USD, sBTC, which is pegged to Bitcoin, and sETH, which tracks Ethereum. They are collectively referred to as Synths.

The entire system's liabilities are settled in sUSD. The Snx V2 version only allows Stakers to mint sUSD by staking Snx. Essentially, this means that by collateralizing Snx, they are borrowing sUSD. Therefore, the minted sUSD represents liabilities for both the users and the entire system.

When the staking ratio reaches over 400% (this ratio will be determined by DAO voting based on market conditions), users will receive inflation rewards and trading fee rewards from Snx. If the staking ratio falls below 160%, and no additional collateral is provided within a 12-hour grace period, or if the sUSD debt is not repaid to bring the staking ratio back above 400%, Stakers may face liquidation risks. To unstake, Stakers need to repay all sUSD debts to withdraw their funds.

Process of Atomic Swaps

Transactions between Snx synthetic assets are completed by destroying one token through a smart contract and minting another. Therefore, under conditions where TVL is satisfied, there will be no slippage except for price delays.

Principle of Dynamic Debt Pools

The total value of all Synths assets in the system = total issued liabilities of the system.

If a Trader exchanges sUSD for other Synths assets, such as sBTC, the total amount of liabilities will increase or decrease with the corresponding Synths price fluctuations. Thus, the overall system's liabilities are not fixed, hence the term dynamic debt pool. The total debt of the system is shared proportionally by all Snx collateralizers. Therefore, a Staker who only participates in minting sUSD without any other operations will also see their debt dynamically change.

Example:

Assume there are only two participants, A and B, who have staked Snx to mint 100 sUSD each. If the current price of BTC is 100 USD, and A uses sUSD to purchase sBTC, the Snx protocol will destroy 100 sUSD from the debt pool and generate 1 sBTC in the debt pool.

If B does not perform any operations, as shown in the figure above, when the price of Bitcoin doubles, both A and B's debts will become 150 sUSD, but A's asset value will be 200 sUSD, while B's asset value remains 100 sUSD. At this point, A can sell sBTC for 200 sUSD and only needs 150 sUSD to redeem their Snx, while B will need to purchase an additional 50 sUSD to redeem their collateralized Snx.

Thus, when a trader incurs losses, their losses will reduce the total value of the global debt pool, thereby lowering the average debt level of all stakers, allowing each staker to share the benefits proportionally, which reduces their debt. Conversely, when a trader profits, it will increase the pool's liabilities. Each Staker will share the losses, meaning they will need to purchase additional sUSD to redeem their Snx.

Snx supports spot atomic swaps and perpetual trading. When the pool size is sufficiently large, the impact of a single transaction on the pool will tend to stabilize, and Stakers can earn trading fees from each transaction. According to the Kelly criterion, in the long run, Stakers will be in a profit mode.

However, if the system is long-short imbalanced, in extreme situations or one-sided markets, Stakers may face situations where others profit while they incur losses. To further reduce Staker risks, V3 provides more mechanisms to maintain system delta neutrality.

What Snx V3 Brings

Liquidity as a Service

After two years of reconstruction and development, Synthetix V3 has upgraded itself to be the liquidity layer for decentralized finance. Synthetix V3 will be launched in phases over the coming months, and in the plan, the existing functions of V2 will become a subset of V3's features. After the final version goes live, developers can directly integrate the Snx debt pool to obtain liquidity for new derivatives markets, including perpetual futures, spot, options, insurance, exotic options, and other derivative markets, without starting from scratch.

Current products in the Snx ecosystem

Examples of applications proposed by Snx include:

Perpetual futures/options/structured products: Support for perpetual futures and leveraged position trading, including basis trading and funding rate arbitrage.

Example: Currently launched Kwenta, Polynomial exchanges, and GMX can also be built on Synthetix V3.

NFT-Fi lending/perpetual contracts: Users can borrow synthetic assets that track NFT trends or create markets for perpetual contracts speculating on future NFT prices.

For example, nftperp.xyz can be built on Synthetix V3.

Insurance markets: Users can purchase insurance contracts for various risks, collateralized in the pool and managed by smart contracts.

For example, Nexus Mutual can be built on Synthetix V3.

Prediction markets/binary options/sports betting: Users can bet based on the outcomes of events.

Example: Election results or sports matches. Currently, Lyra and dhedge are live in the Snx ecosystem.

RWA markets: With reliable oracles and trusted real-world verification, synthetic assets for trading markets on-chain can be developed for items like art, carbon credits, or other off-chain assets.

New Debt Pool and Collateral

As mentioned above, in Snx's Pool and Vault model, Stakers need to temporarily act as counterparty to Traders, and the size of the Staker debt pool determines the liquidity ceiling.

Currently, the single collateral type may have the following issues:

It may cause the system's maximum open interest to be limited by the market value of Snx itself, thus restricting liquidity for traders.
Different synthetic assets have different volatility. The returns and risk-reward for Stakers may not align.
In extreme environments, there may be potential risks of spiral liquidations.

From Kwenta, we can see the total positions currently held across the Snx network. In collaboration with OP incentive activities, the short and long positions of BTC and ETH have repeatedly approached the system's capacity limits.

To address the above issues, V3 has introduced the following features:

a. Isolated Debt Pools

In the existing Synthetix V2, all trades go through a single Snx debt pool, while different synthetic assets have different volatilities, holding risks, and returns. To solve this problem (related cases will be listed in the anti-oracle delay attack section below).

Synthetix V3 has passed the SIP-302: Pools (V3) proposal, allowing Stakers to decide which markets to support liquidity based on their risk preferences. Through governance voting, the collateral types and limits for each pool can be determined, thus limiting risks to a small range. At the same time, it provides Snx stakers with the opportunity to take on higher risks for higher returns. This allows stakers more control over their exposure. For example, they can decide to provide exposure only to mainstream assets like ETH and BTC, while not participating in the debt pools of long-tail assets like NFTs.

b. Multi-Collateral Mechanism

V3 creates a universal collateral treasury system that can accommodate various types of collateral. This means that, in addition to $Snx, Synthetix will also support other assets as collateral for Synths, expanding the market size of Synths assets.

Governance voting will determine which assets, besides the current Snx, will also be supported as collateral, such as voting to allow ETH as collateral. The related eight proposals SIP-302 to SIP-310 have already been passed.

Thus, the new funding pool and treasury system have three main advantages:

Better risk management: Funding pools are linked to specific markets, thus having specific exposures.
Better hedging capabilities: Funding pools are linked to specific markets, allowing for precise hedging.
Greater range of collateral: Stakers can collateralize any assets accepted by the funding pool, addressing the risks of single assets.

Perps V2 and V3 Engines

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

The beta version of Synthetix Perps V1 was released in March 2022, generating over $5.2 billion in trading volume and providing Stakers with $18.1 million in trading fees without any trading incentives.

The Synthetix Perps V2 plan was launched in December 2022 and is the currently used version, capable of reducing fees, improving scalability, and enhancing capital efficiency with isolated margin.
Synthetix Perps V3 is planned for release in Q4 of this year, supporting all V2 features along with new functionalities, such as cross-margin, new risk management features aimed at eliminating market bias. This includes price impact measures and dynamic funding rates.

Founder Kain Warwick stated that Synthetix aims to launch the Perps V3 version and its new decentralized perpetual contract trading front end, Infinex, in Q4 of this year.

The team stated that Infinex will focus on making it easy for users to trade decentralized perpetual contracts. Compared to other decentralized exchanges, it aims to provide a better user experience, eliminating the cumbersome process of signing for each transaction currently required by DEX.

Maintaining Delta Neutrality

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

Synthetix incentivizes balance in the market's long and short open contracts through funding fees and pricing functions for discounts/premiums. The crowded side of trading will incur funding fees, while the other side will receive funding fees.

In centralized trading platforms, funding fees are typically charged every 8 hours, while in Synthetix, funding fees are charged in real-time as positions are held. Similarly, trades that cause imbalances in long-short ratios will incur premiums, while trades that maintain balance will receive discounts. This mechanism encourages arbitrage traders to actively arbitrage when deviations occur, reducing LP risks in one-sided markets.

Oracle Improvement Plan

Anti-Oracle Delay Arbitrage

Oracle latency arbitrage is a major reason why previous DEX platforms could not compete with centralized exchanges.

In previous versions of Synthetix, Synth relied on the Chainlink oracle for price feeds, but the oracle prices updated on-chain lagged behind changes in the spot market prices, creating opportunities for front-running trades. In the context of Synthetix's no-slippage trading, Snx stakers could face significant losses as a result. For example, if a user observes that the ETH price rises from $1000 to $1010 in a short period, but Chainlink still quotes $1000, that user can exchange sUSD for sETH at $1000 in Synthetix. After the oracle price updates, without considering fees, each sETH could yield a profit of $10, and that user's profit comes from the losses incurred by Snx stakers due to front-running.

Supplementary case: Snx's largest competitor GMX currently employs this strategy.

Source: CapitalismLab

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

Example: Selecting the lowest price for spot Bitcoin based on the time-weighted average prices (TWAP) from Chainlink, Pyth, and Uniswap.

Synthetix (Snx) is also exploring two solutions to address the oracle latency arbitrage issue.

Hindsight Oracle Solution: A solution proposed in collaboration with the Pyth team. This solution reduces the possibility of oracle latency arbitrage through asynchronous trading and configured delay times. This helps lower transaction costs on DeFi platforms, making them more competitive.
Chainlink's Low-Latency Data Source: Another solution provided by the Chainlink team for Synthetix. This solution aims to provide low-latency data sources to reduce opportunities for oracle latency arbitrage. This solution has advantages over the hindsight oracle solution in some aspects, such as not relying on third-party executors (keepers) to complete trades, thus lowering transaction costs while protecting the data privacy of data providers.

Introduction to Pyth and Snx Collaboration:

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

Off-chain oracles achieve fast on-chain prices at competitive fees. They play an important role in significantly reducing transaction costs. By addressing the oracle latency arbitrage issue, the trading fees for major currency pairs on Synthetix are currently between 0.2% and 0.6%, comparable to Binance's premium VIP users.

Cross-Chain Solutions

Teleporters - For Stablecoins

The SIP-311 proposal introduces the concept of Teleporters. Once Teleporters are 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 where Synthetix is deployed, without cross-chain bridges or transfer slippage.
It allows the liquidity layer to share collateral across all chains.
It enables fast movement between chains without challenging verification times, as well as returning from L2 to L1.

Cross-Chain Liquidity Pools

For Debt Pools

The SIP-312 proposal enables markets and mining pools on all chains to access the current state of all on-chain combined collateral.
This means that Perps markets can be quickly deployed to new chains and can utilize the collateral from existing debt pools on Optimism and Ethereum mainnet.

As mentioned above, through Teleporters and cross-chain liquidity pools, the Synthetix liquidity layer can expand to any EVM chain, and new chains can directly obtain liquidity support from other chains upon deployment.

Economic Model + Revenue Data

The revenue of the Synthetix protocol comes from several different channels. Mainly through trading fees from perpetual contracts and synthetic asset exchanges, perpetual contract and Snx liquidation fees, as well as fees during the minting/burning process of synthetic assets. All revenue from the protocol will be distributed to integrators and Snx stakers.

Revenue Distribution for Integrators

Products developed by integrating the Snx protocol, such as Kwenta, are referred to as integrators. Snx rewards a certain percentage of fees based on trading volume, paid in Snx: 10% for the first $1 million in fees, 7.5% for fees from $1 million to $5 million, and 5% for fees over $5 million. Integrators can freely decide how to use these fees, such as empowering their own platform tokens.

The Snx development team no longer operates the front end themselves but hands over specific business to integrators, adopting incentive schemes for integrators, which will enhance network effects and are expected to be integrated by more products, becoming important components of DeFi.

User Growth Situation

As of the data published on July 23, Synthetix's current TVL, monthly trading volume, and fee income are comparable to its competitor 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 liquidity incentives from the Optimism chain this year, and trading users of Synthetix Perps will receive OP airdrop rewards.

The OP incentives started on April 19, and the current OP incentives can cover about 80% of the transaction fees.

According to Messari data, Perps has seen a strong push in trading volume due to subsidy incentives. The number of user trades and trading volume data has grown rapidly.

Based on the trend of the number of on-chain interaction addresses, despite the increase in trading volume, the number of users has not significantly grown. This indicates that the largest increment in trading volume comes from existing users increasing their trading activity.

The OP reward program will continue until September 13, making it easier to understand retention rates after Q3.

Trading User Data Trends

Data Source:

https://dune.com/queries/452148/859385?1+Project+Namet6c1ea=Synthetix&4+End+Dated83555=2023-06-28+00%3A00%3A00

PE Level

As trading volume increases, revenue rises, and staker earnings increase, Snx's PE has returned from a bull market high of 50X to a more reasonable range of 10X - 15X.

Staker Weekly Fee Earnings Data

Data Source:

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

Exploration of New Token Models

Snx is currently in a fully circulating state, with approximately 5% inflation rewards provided to Snx stakers annually.

In August 2022, Synthetix founder Kain Warwick proposed SIP-276, suggesting a cap of 300 million Snx tokens, with minting to stop once this number is reached. However, this 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, allowing users to deposit Snx without facing market risks or considering hedging needs. Initially, the financial committee will fund this staking pool, but in the future, part of Synthetix's protocol fees may also be allocated to this staking pool. Kain emphasized that this simpler staking method aims to attract more new users into the Synthetix V3 system. This proposal is currently under discussion and is expected to further increase Snx staking rates.

Summary

In the long run, the decentralized derivatives trading sector 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 improve the protocol's capital efficiency and security, release liquidity ceilings, and enhance user experience, attracting more users to participate in the Synthetix protocol. After the full functionality of V3 goes live, it will usher in new business increments and valuations, with the potential to be integrated by more products and become an important component of DeFi.

However, at this stage, new user growth is relatively slow, and the development cycle required for the full launch of V3's features is uncertain. The revenue situation of SNX staking under the new token model and the retention rates after Q3 will be important valuation indicators for SNX holders in the short term.

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