Synthetix V3 Application Prospects and Data Interpretation

Original authors: BitAns, Krypital Group

This article is for communication and learning purposes only and does not constitute any investment advice.

After the bankruptcy of FTX, the trading volume and attention for decentralized derivatives exchanges have significantly increased. In recent years, with the improvement of L2 and various Appchain open-source architectures, the reliability and concurrency performance of DEX have greatly improved. The Dex PERP track has become one of the best-performing products in the bear market. As the industry continues to explore decentralization, these products will undoubtedly become an important part of the industry's future.

Currently, the mainstream decentralized derivatives designs on the market mainly include the Orderbook model represented by Dydx and the Pool and Vault model represented by Snx. Today, Snx has evolved from an asset synthesis platform in 2017 to a modular liquidity protocol, aiming to become a universal liquidity layer for on-chain financial products. New features and improvements are expected to bring new business increments and valuations. In this article, we will interpret Snx V3 through data and application scenarios.

TOC：

I. Existing Mechanism and Issues of Snx V2

II. New Functional Modules of Snx V3

A. Liquidity as a Service

B. New Debt Pool and Collateral Mechanism

C. Perps V2 and Perps V3 Engine

D. Oracle Improvement Plan, Anti-Oracle Delay Arbitrage

E. Cross-Chain Liquidity Solutions

III. Economic Model + Revenue Data

Operating Mechanism of Snx V2

To better understand V3, we need to briefly review the existing design of Snx and the various issues it faces.

There are two core user types in the Snx ecosystem:

1. Stakers

Stakers pledge Snx to earn system inflation rewards and trading fees from Traders.

2. Traders

Users who utilize atomic swaps or Perps trading within the Snx protocol.

Principle of Synthetic Assets

The principle of staking stablecoins is to generate tokens equivalent to USD through collateralized assets. 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 has synthetic assets such as sUSD, which is pegged to 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. In the Snx V2 version, only Stakers can 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 user and the entire system.

When the staking ratio reaches 400% or higher (this ratio is determined by DAO voting based on market conditions), Stakers 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 the sUSD debt is not repaid to bring the staking ratio back above 400%, Stakers may face liquidation risks. To unstake, Stakers only need to repay all sUSD debts to withdraw their collateral.

Process of Atomic Swaps

Trading between Snx synthetic assets is completed through smart contracts that destroy one token and mint another. Therefore, as long as the TVL conditions are met, 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 price fluctuations of the Synths. Thus, the overall liabilities of the system are not fixed, hence the term dynamic debt pool. The total debt of the system is collectively borne by all Snx collateralizers in proportion. Therefore, a Staker who only participates in minting sUSD without any other operations will also see their liabilities dynamically change.

Example:

Assuming 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, when A uses sUSD to purchase sBTC, the Snx protocol will destroy 100 sUSD from the debt pool and mint 1 sBTC in the debt pool.

If B does not take any action, as shown in the above figure. When Bitcoin doubles in price, both A and B's liabilities become 150 sUSD, but A's asset value is now 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 needs 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 for all stakers, allowing each staker to proportionally share the benefit, effectively reducing their debt. Conversely, when a trader profits, it will increase the pool's liabilities, and 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 trade 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's long and short positions are unbalanced, in extreme situations or one-sided markets, Stakers may face scenarios where others profit while they incur losses. To further reduce Staker risks, V3 provides more mechanisms to maintain system delta neutrality.

What Does Snx V3 Bring?

Liquidity as a Service

After two years of reconstruction and development, Synthetix V3 has upgraded itself to be a liquidity layer for decentralized finance. Synthetix V3 will be rolled out in phases over the next few months, and in the plan, the existing functions of V2 will become a subset of V3's features. After the final version is launched, 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

The application cases proposed by Snx are as follows:

Perpetual Futures/Options/Structured Products: Supports trading of perpetual futures and leveraged positions, 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 pegged to NFT trends or create markets for perpetual contracts speculating on future NFT prices.

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

Insurance Market: 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 Market: With reliable oracles and trusted real-world verification, synthetic assets for trading markets on-chain can be developed for items such as artwork, 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 counterparties for Traders, and the size of the Staker debt pool determines the liquidity ceiling.

Currently, a single type of collateral may lead to the following issues:

It can cause the system's maximum open interest to be limited by the market cap of Snx itself, meaning traders' liquidity is restricted, and different synthetic assets have varying 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 for BTC and ETH have repeatedly approached the system's carrying limits.

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

Isolated Debt Pools

In the existing Synthetix V2, all trades go through a single Snx debt pool, while different synthetic assets have different volatilities, risks, and returns. To solve this issue (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 containing risks within a small scope. At the same time, it provides Snx stakers with the opportunity to take on higher risks for higher returns. This gives stakers more control over their exposure. For example, they can choose to provide exposure only to mainstream assets like ETH and BTC, while not participating in the market debt pool for long-tail assets like NFTs.

Multi-Collateral Mechanism

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

Through governance voting, it will be decided which assets, in addition to the current Snx, will also be supported as collateral, such as allowing ETH to be used as collateral. The related eight proposals SIP-302 to 310 have already been passed.

Thus, the new funding pool and vault system has 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 stake any assets accepted by the funding pool, mitigating the risks of a single asset.

Perps V2 and V3 Engine

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 solution was launched in December 2022 and is currently in use, capable of reducing fees, improving scalability, and enhancing capital efficiency with isolated margin.

Synthetix Perps V3 is planned for release in the fourth quarter of this year. Synthetix Perps V3 will support all v2x features, along with some new features, such as cross-margining and new risk management functions aimed at eliminating market biases. 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 the fourth quarter 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 by eliminating the cumbersome process of signing for each transaction required by current DEXs.

Maintaining Delta Neutrality

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

Synthetix incentivizes balance between long and short open contracts in the market through funding fees and premium/discount pricing functions. 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 an imbalance in long and 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, Synths relied on the Chainlink oracle for pricing, but the oracle prices on-chain lagged behind the price changes in the spot market, creating opportunities for front-running. 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, while 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 earn a profit of $10, with the user's profit coming from the losses incurred by Snx stakers due to front-running.

Supplementary case: The strategy currently employed by Snx's largest competitor, GMX.

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.

1. Hindsight oracle solution: A solution proposed by Synthetix 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.

2. 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 certain 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 pricing at competitive fees. They play an important role in significantly reducing transaction costs. By addressing the oracle latency arbitrage issue, the current trading fees for major currency pairs on Synthetix range from 0.2% to 0.6%, comparable to Binance's premium VIP users.

Cross-Chain Solutions

• Teleporters - For Stablecoins

The SIP-311 proposal introduced 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 the need for 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 allows markets and mining pools on all chains to access the current status 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 once new chains are deployed, they can directly obtain liquidity support from other chains.

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/destroying 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 an important DeFi component.

User Growth Situation

As of the data released on July 23, Synthetix's current TVL, monthly trading volume, and fee revenue are comparable to its competitor GMX, but the total number of daily and monthly active users is far lower than GMX and dydx.

Perp V2 Trading Volume

Synthetix Perps 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 incentives can cover about 80% of the transaction fees.

According to Messari data, Perps has seen a strong boost in trading volume due to subsidy incentives. User trading frequency and volume data have grown rapidly.

Despite the increase in trading volume numbers, the number of users has not significantly grown, as indicated by the trend in the number of on-chain interaction addresses. This means that the largest increment in trading volume comes from existing users trading more.

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

• 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 Levels

With the increase in trading volume comes an increase in revenue and staker earnings, and Snx's PE has returned from the bull market level of 50x to a more reasonable range of 10x-15x.

• Weekly Fee Earnings Data for Stakers

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 each year.

In August 2022, Synthetix founder Kain Warwick proposed SIP-276, suggesting that the issuance of Snx be capped at 300 million tokens, with further issuance ceasing once that 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, a portion 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.

Conclusion:

In the long run, the decentralized derivatives trading track 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. Once V3 is fully launched, it will usher in new business increments and valuations, with the potential to be integrated by more products, becoming an important DeFi component.

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

Material References:

https://blog.synthetix.io/tokenomics-discussion-review/

https://blog.synthetix.io/what-is-synthetix-v3/

https://twitter.com/jonathanykh/status/1632604358960644098

https://www.techflowpost.com/article/detail_11555.html

https://dune.com/synthetix_community/synthetix-stats

https://www.panewslab.com/zh/articledetails/p4tt0ls1.html

https://www.panewslab.com/zh/articledetails/jbyg555d.html

https://www.panewslab.com/zh/articledetails/tfrnsgg2.html

https://mint-ventures.medium.com/synthetixs-ambitions-a-derivatives-trading-market-with-unlimited-liquidity-a2b79279687b

https://twitter.com/synthetix_io/status/1634285867555758080

https://blog.synthetix.io/what-is-synthetix-v3/

https://medium.com/@doge_bull/binance-killer-summer-b32cce1c22d3

https://mirror.xyz/cavalier.eth/nOTmVQcole7f0mnqhF93PHO2qbCMm1Y0JAAdiYX9tjU

https://twitter.com/NintendoDoomed/status/1597225616340045826

https://messari.io/report/state-of-synthetix-q2-2023?referrer=all-research

https://mirror.xyz/cavalier.eth/nOTmVQcole7f0mnqhF93PHO2qbCMm1Y0JAAdiYX9tjU