<In-depth Research>Synthetix’s ambitions: A derivatives trading market with unlimited liquidity

By Li Yuxuan, Mint Ventures

1. Key points

1.1 Core investment logic

Synthetix is worth positive attention now for the following reasons:

• There is a huge space on the decentralized derivatives trading racetrack, and the potential is obvious compared with the decentralized spot trading (Uniswap) and the centralized derivatives trading (BITMEX).
• Racetrack wise, the most positive aspect of Layer2 is the decentralized derivatives trading. With the launch of Arbitrum’s Mainnet and Optimism coming soon, Layer2 has already arrived.
• Synthetix’s core business logic-Dynamic Debt Pool-has been tested and proven for more than two years. With a dynamic pool of debt, Synthetix promises unlimited liquidity for unlimited kinds of crypto assets, with stronger network effects and easier winner-takes-all.
• Synthetix’s core features: leverage trading basded on Layer 2 is coming online soon, which is expected to generate new business growth and higher valuations.
• There are four sub-projects in the System that could launch tokens that will be distributed to SNX holders.
• The team is proactive and willing to take responsibility. The project management is to high standards and the community development is sound.

1.2 Valuation

Based on data on historical valuations and horizontal valuations, we believe that the current valuation of SNX is reasonable and slightly undervalued. See 4.3 Valuation for detailed analysis

1.3 Main risk

The main risks Synthetix faces are: regulatory risk, oracle risk, risk from delay in launching key functions, risk of falling short of expectations and risk of being replacement by similar projects. See 3.4 Risks for detailed analysis.

2. Project Overview

2.1 Detailed introduction of the Project

Synthetix defines itself as a “The Derivatives Liquidity Protocol”. Its main business is synthetic asset and derivatives trading. There are two types of roles within Synthetix’s major business architecture:

• The first is Trader: Trader can trade dozens of assets in Synthetix, including cryptocurrencies, equities, forex, commodities, etc. Trader can trade in Synthetix with no slippage, and can trade in real time according to the price generated from oracle, and the proceeds can be settled and withdrawn in real time
• The second is Staker: Staker is essentially liquidity provider, and Staker stakes SNX (Synthetix’s project token) to provide trader with nearly unlimited liquidity under a “dynamic debt pool” mechanism. Staker can receive SNX mining awards and trader’s trading fees.

Currently Synthetix only provides services on ETH and Optimistic ETH chains. Briefly, the current major business processes for Synthetix are as follows:

• a. Mint: User stakes SNX to generate sUSD with a 500% collateral rate. sUSD is always anchored at 1USD.
• b. Trading: On the Kwenta exchange (and before that the Synthetix.exchange), users can trade with sUSD for any kind of system-supported synthetic assets (hereinafter referred to as synths), including:
• Cryptocurrency assets, which include both sTokens (assets for long positions) and iTokens (reverse synthetic assets for short positions), such as sETH and iETH, sDefi, etc.;
• Forex assets, such as sEUR and sJPY;
• Equity assets, such as sTSLA and sFTSE (FTSE100);
• Commodities assets, such as sXAU and sXAG.

The process of trading actually burns sUSDs and mints synths.

• c. Burn : After completion of transaction, user can exchange the synths into sUSD (actually burn the synths and re-mint sUSD), and return sUSD to retrieve SNX (Due to the design of the dynamic debt pool, it is not possible to exchange back all the SNX that have been staked, and this mechanism will be detailed in the following sections).

It is worth noting:

• a. The underlying asset used for stake is not stable currency or ETH, but the token SNX of the project itself, whose price fluctuates more. Therefore, on the one hand, the project encourages people to increase the stake rate to maintain stability of the project. The specific ways are as follows: 1) When the user’s stake rate is above the target stake rate of the System, new SNX tokens will be issued (equivalent to single currency stake mining); 2) When the user’s stake rate is higher than the target stake rate, the transaction cost of different assets ranges from 0.1% to 1%, but most of them are 0.3%. The proportions that users get are determined according to the proportion of users’ debt (sUSD minted by users) in the total system debt; 3) On the other hand, when the user’s stake rate is less than 200% for more than 2 days, the System liquidation will also be triggered.
• b. Users can buy synths directly without minting sUSD. If a user wants to short BTC, he can convert USDT into sUSD through curve, and then buy iBTC in synthetix
• c. In the process of synths trading, the price is based on the price generated from oracles. There is no slippage, only 0.3% of the commission fee + gas fee is invoked (most of the time), and the transaction will not fail. There is no AMM here, and its counterparties are not other individuals, but the whole System. The whole process is supported by “dynamic debt pool”.

2.1.1 Dynamic Debt Pool

Dynamic debt pool is the original design of SNX, an elusive core concept that I personally find most interesting. It is the dynamic debt pool that supports the real-time exchange and no slippage features of Synthetix transactions.

“Dynamic debt” means that the liabilities of users and the system change in real time. When the user stakes SNX for minting sUSD, the minted sUSD is considered as newly generated debt of the System. After exchanging the sUSD into synths, the debt will rise and fall with the appreciation or depreciation of synths, and the debt of the System is always borne by all the stakers of SNX in proportion. As a result, the debt of a user who only participates in the minting of sUSD without any other operation will also change dynamically.

The simplest example is as follows: Suppose there are only A and B in the System, and they each mints 100 sUSDs.

In the end, the debt of A and B both become 150 sUSD, but the asset value of A is 200 sUSD, and the asset value of B is still 100 sUSD. At this time, A sells sBTC for 200 sUSD, and only needs 150 USD to redeem SNX, while B needs buy additional 50 sUSD to redeem the staked SNX.

The key to understanding this is that for a user who stakes SNX to generate sUSD at any time, he always gets a fixed amount of sUSD asset, while always carrying a fixed proportion of sUSD liabilities. When he stakes SNX to generate sUSD, the two are exactly equal; and the total amount of debt will change in real time according to the total market value of synths, so his debt will also change with shifts in the total market value of synths.

It can be seen that for SNX stakers, Synthetix debt pool model is actually a dynamic zero-sum game (transaction fees are also allocated to stakers in proportion): for a staker, profit may derive from more increases in asset price compared to other stakers, or less declines in asset price. In other words, for users participating in the stake of Synthetix, they are essentially going long on “their own investment capacity / investment capacity of other participants”. Holding sUSD without making any moves is certainly an option, but it exposes yourself to the risk of “I’m losing money because other people are too good at investing.” According to Taleb, when a user stakes SNX to generate sUSD, he has already “sunk in the game”. This is a bold design because all people are taking risks so that all are truly “stakeholders”.

The trading experience supported by the dynamic debt pool model is excellent: No slippage and real-time transaction (without considering the oracle delay), and almost unlimited liquidity of all trading objects (within the security scope of the protocol). Assuming that Layer 2 and leveraged trading can go online as expected and the experience meets the expectation, then the experience of trader will be excellent.

But for stakers, the situation is much more complicated, especially when it concerns “if others make money, I will really lose money”, a highly game-oriented logic that is intuitively difficult to accept. But in fact, when comparing the dynamic debt pool model of synthetix, a decentralized derivatives exchange, with the AMM model of uniswap, a decentralized spot exchange, we can see many similarities:

Uniswap distributes the transaction fees to LP in full through AMM model to encourage LP to provide liquidity, so as to give swappers the experience of real-time transaction and low slippage.

Synthetix distributes the transaction fees and its token incentive through the dynamic debt pool model to stakers in full, which encourages stakers to provide liquidity, thus providing traders with experience of real-time transaction and low slippage.

Why no AMM in Synthetix

For derivatives trading, the experience brought by illiquid trading objects is disastrous, which is why many large-scale centralized derivatives exchanges still support only a few trading objects (such as Bybit). The liquidity of the common AMM model is based on distinguishing between trading objects, and the liquidity correlation between different transaction pairs is very negligible. The mechanism of Synthetix not only enables a single trading object to have unlimited liquidity, but also facilitates all trading objects to share this liquidity.

2.1.2 Business data

As of 23:00 June 23 (GMT+8), Synthetix’s core data is as follows:

• Staking data: The current TVL is 747 million US dollars; 70% of the SNX in circulation are staked on the official website; In addition to transaction fees, Synthetix uses additional tokens to encourage users to provide liquidity. At present, the annualized income from transaction fee is about 9%, while the income from staking SNX is about 26%, which together constitute 35% of stacking APY.

• Transaction data: 59,582 transactions in total have been executed; The accumulated trading volume is close to 6.56 billion US dollars; In the past 24 hours, the trading volume exceeded 865 million US dollars (including the transaction in sUSD). Since February 2020, transaction fees have exceeded $23.8 million. The total value of Synthetic assets in circulation exceeds 657 million US dollars.
• Besides major business, Synthetix also operate in:
• Lending: Synthetix supports users to stake renBTC to obtain sBTC or sUSD, and ETH to get sETH or sUSD. The purpose is to give users who are not willing to hold SNX access to the System (the loan here is ordinary mortgage loan, that is, fixed debt loan). At present, through this arrangement, a total of 33 million US dollars of debt has been generated, most of which is in sUSD. The specific data is as follows:

• Liquidity Mining: In order to maintain the long-term and stable development of the system, Synthetix has encouraged a variety of behaviors, such as: maintaining the price stability of sUSD by stimulating the curve’s sUSD pool.
• Go short: Encourage users to stake sUSD to short sBTC and sETH. Because there are too many long positions of BTC and ETH in synths, the System debt will grow too fast in the unilateral rises of ETH or BTC, which may affect the stability of the whole System. From the perspective of reducing systemic risk, Synthetix encourages users to stake sUSD to short sBTC and sETH. The current available data is as follows.

• Binary Options: Right now, options trading volume is low, in the USD100, 000 range.
• xToken: Simply put, xToken (which is also an ERC-20 token) is an investment strategy package corresponding to the current cryptocurrency, which is used to balance the stake yield and liquidity of the currency. For example, the strategy of xSNXA can be described as “aggressive stake of SNX + cautious bullish ETH”. In addition to xSNX, tokens, such as xAAVE, xKNC, xBNT, have been launched at present. It is xSNX and xBNT pools that had suffered Price Oracle Attacks some time ago. The current total AUM(Asset Under Management) of Synthetix is around USD 23 million.

• dHedge：dHedge is a distributed asset management protocol based on Synthetix that enables users to manage multiple synthetic assets without having to manage them in custody. dHedge is backed by a number of organizations, including Framework Ventures, Three Arrows Capital, BlockTower Capital, DACM, and Maple Leaf Capital.

For traders, after the launch of Layer 2 and leverage trading, creating a pool of assets at dHedge allows them to take advantage of Synthetix’s zero-slippage and unlimited liquidity trading mechanism and to attract users to invest and gain revenue. For the masses investors, it gives them one of the best ways to share in the gains of top traders: No custody, and all data coming from the chain. The following chart shows dHedge’s top five asset pools measured by AUM.

2.1.3 Product integrity

Needless to say, when Layer 2 trading and leverage trading are not yet online, Synthetix cannot be called a complete product. After all, how can a trader bear only a double leverage to long / short and hundreds of Gwei, at the same time? But from another angle, which market segment benefits the most from Layer 2? There is no doubt that it is derivatives trading on chain. As for product integrity, we will discuss it in detail in 2.2 Development and Roadmap.

2.1.4 System stability

There have been many critics of Synthetix, including many KOLs. To sum up, the main arguments of the critics are:

The combination of SNX’s token model and stake model is too Ponzi-looking; High stake rate and long lockup period push up the token price: Once the SNX token price falls, and sUSD de-anchors, the whole System will fall into a vicious cycle.

For example: SNX, a project that relies on the synthesize assets based on staking of original token, is actually a mansion built on the beach. Similar models have already been used in China’s A-share stock market for years. The company will hype up its share price, stake its shares to brokers, and plow the cash back to speculate in the stock market. The essence of this model is to first attract market funds by putting on a show to propel up share price and then lock the liquidity through the locked positions or burning mechanism, ensuring continuing net inflows of fund to prop up share price. This kind of game is very dangerous, because when the price is too high, the whole situation will become a barrier lake. As long as someone starts to sell, it will immediately cause a catastrophic burst, resulting in a vicious cycle. That is, SNX plummets and staked assets are subject to mandatory liquidation; SNX plummets further, and more staked assets are forced to be liquidated.

This concern is justified to some extent. As the stability of the system and the liquidity of the transactions are mostly dependent on the staked SNX, the collapse of SNX would lead to trust and liquidity crisis and further result in the de-anchoring of sUSD, seriously shaking the stability of the whole system, let alone the derivatives transactions built on this system.

Actually, Synthetix’s design, which initially sets the mortgage rate at 750% and gives incentive to users above the target mortgage rate, is designed to mitigate the negative impact of SNX price drops on protocol stability.

How does the protocol actually resist risk? We choose the stability of sUSD as the index of system stability. Looking back at the price fluctuations of sUSD, we can clearly see that SNX price dropped by more than 50% in February to March in 2020, sUSD price once even fell to 0.8, with the price of sUSD lower than US $1 for a long time ever since the drop. Arguably, Synthetix entered the moment of maximum risk.

Token Prices from Jan 2020 to Apr 2020: sUSD VS SNX, Source：glassnode

From May 18th to now, SNX prices have also seen a drop of more than 75% from the peak, but sUSD is anchored very steadily.

Figure Below:

Token Price in Last Four Months: sUSD VS SNX, Source：glassnode

In fact, we can see that since the SNX token price rose to 5U in July last year, the stability of the system has been greatly improved, which is reflected in the more “stable” price of sUSD, basically fluctuating between 1 and 1.05U.

sUSD VS SNX Price Fluctuations from December 2018 to Now, Source：glassnode

Therefore, we believe that SNX system is indeed a highly reflexive system. The rise and fall of SNX will further promote the further rise and fall of its price, and the fall of SNX price will affect the stability of Synthetix system.

However, there is a certain threshold in between, and when the price of SNX exceeds this threshold, Synthetix’s system stability will be significantly improved. In our view, SNX prices have now passed this threshold and Synthetix’s system stability has been validated in this relatively extreme market.

2.1.5 Community governance

Synthetix is reputed as a prominent example of community governance. At present, Synthetix’s community governance is a set of system composed of four DAOs that are related and restricted mutually. Although it is a little complicated, it fully considers the interests of developers, wale users, project parties and others, with a good balance between decentralization and efficiency achieved.

To put it simply, Synthetix governance is divided into four DAOs including The Spartan Council, ProtocolDAO, GrantsDAO and SynthetixDAO. Among them, The Spartan Council and ProtocolDAO balance each other, serving a decisive role in the adjustment of key parameters of the protocol (among them, the Spartan Council used the square root to restrict large token holders when calculating voting rights); whereas GrantsDAO and SynthetixDAO could help manage community funds;

Review more information at https://www.chainnews.com/articles/898986381770.htm and thinking of founder Kain when luanching Spartan Council

2.2 Past development status and roadmap

2.2.1 Past development status

• Havven is the predecessor of Synthetix, a dual token system stablecoin project founded by Kain Warwick in 2017
• From January to March 2018, Havven raised a total of $30.3 million through an ICO at a price of 0.5USDT/HAV (known as SNX later on)
• At the end of July, 2018, Havven was launched, with business briefly described as “issuing stablecoin nUSD through staking original token HIV”.
• In early December of 2018, the business is transformed to synthetic assets,with the project officially renamed as Synthetix. At the same time, HAV also changed its name to SNX, and nUSD changed its name to sUSD.
• Synthetix was successfully launched on the ETH main net in February 2019.
• In March, 19, a “bold” adjustment was made to the SNX token model. In short, the total number of SNX was increased from 100 million to 245 million, with extra part released to stakers as an incentive within 5 years, with the lock position period of one year. There was a lot of criticism at the time, but the findings showed that: SNX’s staking rate has increased from 20% to 80%; at the same time, the price of SNX tokens rose nearly 50-fold over the forthcoming eight months.
• The content launched in the first half of 2020 by the team include: make ETH as collateral, launch stock index type synthetic assets (sFTSE \ sNEKKI), launch Bbinary options, start incentivizing going short on ETH, add clearing mechanism and ect.
• Before Defi Summer in 2020, Synthetix was always the head protocol of DeFi’s TVL, second only to Maker and ahead of Compound and Uniswap, etc., even for a long time. Of course, its collateral all being SNX is the fundamental reason.
• Synthetix has the highest requirements for miannet’s performance among mainstream DeFi products. Currently, the team is well aware of the point that current performance of ETH lacks far behind the derivatives exchange requirements. Given that, Synthetix is the most active to embrace Layer 2 among major DeFi projects, with partners being Optimistic Ethereum(OE).
• Synthetix has been actively looking for Layer 2 solutions early since the first half of 2020 and has engaged in Demo of OE Trading
• Synthetix began staking and retrieving SNX in a test environment since September 2010
• In January 21, although it is risky to split SNX liquidity on Layer1 and Layer 2, staking and minting operations are already available on OE, with the team currently designing different incentives to encourage staking on L1 and Layer 2.
• At the moment, the core trading can only take place on Layer1 and the team plans to switch trading to Layer 2 with the launch of OE mainnet in July
• Although OE is supported by Uniswap and Link in addition to Synthetix, wrong selection of Layer 2 technical roadmap is still a major mistake and waste that can happen to Synthetix, just as the recent OE/Arbitrum debate

2.2.2 Roadmap

On May 20th, Kain Warwick posted an article https://blog.Synthetix.io/a-little-dash-of-hopium/, which details the plans of Synthetix in remaining time this year, as well as the suggestions to split Synthetix into v3 and v2x versions for joint operation.

The scope of v2x is already basically defined, and several of the most important updates to the protocol are in v2x, including:

• Layer 2 transaction: “… We are only a few weeks away from BTC, ETH and Link transactions in Layer 2”.
• Debt consolidation between Layer1 and Layer 2 depends on thorough preparation
• Synthetic asset “transmitters”
• Staking incentive migration: Staking incentive to be migrated to Layer 2 follow-on
• Cross-chain debt snapshot: Once this is done, the debt consolidation of L1 and Layer 2 can begin
• Launch Layer 2 short selling and then abolish reverse synthetic asset (iSynth) on Layer1
• Leveraged trades: Leveraged trades on OE will start at 5–10x and may eventually achieve more than 50x leverage.
• TWAP swap
• Lending function improvement: There are currently three different ways to realize lending in Synthetix. These three ways all need to be packaged and consolidated into a single solution to reduce technical debt and complexity and to allow ETH and BTC to become scaled collateral. This unified lending system needs to be integrated into Kwenta and Staking to ensure the scaling of synthetic asset over L1
• Limit Order: The limit order was originally in V3 range, but depending on the possible changes in the schedule above, it may make sense to move the realization of limit order back to V2X. This is the only function that has yet to be implemented in the same way as a centralized exchange

Additionally, in this article, Kain suggests that Kwenta, the trading protocol, be split into a separate team, with the possibility of introducing tokens that will be distributed to SNX holders. In addition, the binary option protocol Thales, Layer 2 native option Lyra, and funding protocol Aelin may also be issued independently.

It’s also worth noting that Kain specifically mentions other acquisitions and expansion projects in his 2021 plan.

2.2.3 Team, investors and partners

Founder: Kain Warwick

Kain Warwick, a former guitarist and lead vocal, dropped out from the University of Sydney in 2000. Reckoned as a serial entrepreneur, prior to founding Synthetix, Kain was the co-founder and CEO of Blueshyft, a retail payments network with over 1200 outlets in Australia.

COO : Jordan Momtazi

Jordan previously served as VP of Business Growth in Synthetix and is currently a member of Sparta’s Board of Directors. Prior to that, Jordan was also a serial entrepreneur with extensive experience in the sales field and was in charge of corporate partnerships in the Sydney region at PayPal. He also worked at Blueshyft where he was responsible for business growth.

CTO： Justin Moses

Justin Moses, serving as a technical advisor back then, was also a partner to Kain during his time at Blueshyft,

Post raising $30 million in ICOs in early 2018, in October 2019, Framework purchased 5 million SNX tokens for $3.8 million. Framework has been deeply involved in Synthetix, promoting series of improvements and optimizations for Synthetix, and also listed Synthetix’s website as a “liquidity partner”.

In February 2021, Synthetix announced the success of 12 million US Dollars funding led by Paradigm, Coinbase Ventures, and iOSG Ventures. The investors buy SNX tokens directly from the Synthetix DAO Treasury and “will provide liquidity through SNX collateral, involving in and contributing to the development of community governance systems.”

Synthetix’s current liquidity partners include: Framework Ventures、ParaFi Capital、Three Arrows、XBTO、IOSG Ventures、DTC Capital、Hashed 、DeFinance Capital

3. Business Analysis

3.1 Industry analysis

Synthetix belongs to the niche market of decentralized derivatives exchange and we’ll start with industry analysis

3.1.1 Decentralized derivatives trading has huge potential

According to centralized exchange market data, the transaction volumes of derivatives (including perpetual contracts, futures and options) are similar to that of spot (according to 21Q1 data, monthly perpetual contracts trading volumes were reaching 5 trillion dollars whereas futures and options were traded at 70 million dollars every month. Retrieved from https://tokeninsight.com/zh/report/2636 https://tokeninsight.com/zh/report/2672) . The growth rate of derivatives trading volumes is much higher than that of spot.

Today, the difference of relative Uniswap and Pancakeswap trading volumes at their peak as compared to centralized exchange is less than 10 times, but decentralized derivatives trading volumes are still less than centralized derivatives trading volumes by orders of magnitude (Binance daily derivative trading volumes already reaching over $50 billion dollars whereas combined daily transaction volumes of all decentralized derivatives stand at around $100m dollars only), indicating significant potential.

In addition, the recent regulation of derivatives on centralized exchanges in China will also benefit decentralized derivatives projects.

3.1.2 Synthetic assets have the expectation of “trading everything”

Synthetic assets can create more trade targets. For instance, sDeFi currently supported by Synthetix (an index made up of 14 DeFi blue chips), sCEX (an index made up of seven exchange platform coins) and others are actually very easy to realize. In theory, creating a new asset requires only community proposal, some code, and oracle support.

Synthetic asset projects create traders the expectation of “trading virtually any trade object”.

3.1.3 Top Organizations Hold Racetrack

The Figures above are Defi pulse Derivatives Lock-in Data

(In addition to Nexus Muual in the insurance market and Barnbridge and SNX in the interest rate market, the funding situation of the above project is as follows:

DYDX has gained funding from A16Z, Polychain and Three Arrows;

UMA has received investment from IOSG, dragonfly, coinbase ventures, and bain capital ventures;

Futureswap has gained funding from Framework Ventures;

]DDX’s has received investment from Paradigm、dragonfly、Synthetix founder Kain Warwick、Aave founder Stani Kulechov and Compound founder Robert Leshner

ribbon finance received funding from dragonfly, coinbase ventures, ETH co-founder Joseph Lubin, Synthetix founder Kain Warwick and uma founder Hart Lambur)

While most of these projects has received limited funding, the investment from top institutions and DeFi project founders are solid proof of the market potential of decentralized derivatives.

3.1.4 Problems facing

The potential is huge as numerous problems also exist currently. Apart from market education issues, further problems hindering the demand of on-chain derivatives are as follows :

1. Transaction costs problems exist. Derivatives exchanges themselves are much more complex than spot exchanges such as Uniswap in smart contract design, and derivatives traders trade more frequently with higher sensitivity to strike prices and transaction fees. Currently, products on Ethereum are restricted by the Ethereum network and face serious problems such as high network fees and transaction delays. As Layer2 will solve or partially solve this problem, on-chain derivatives trading projects are all actively practice of Layer2. Except for Synthetix’s active partnership with OE, dYdX cooperates with StarkWare as it supports Zkrollup technology, Mirror runs on Terra.
2. Liquidity problems exist. Centralized exchanges match orders through order books. Users are counterparties to each other. Without market makers, it is difficult to match orders efficiently only with the liquidity provided by users’ own split buying and selling demands. On decentralized exchanges, especially before AMM becomes famous, market makers were too inefficient in the chain of decentralized derivatives exchanges. Even after the popularity of AMM, they still could not provide liquidity effectively (only a few projects with TVL over 50 million USDT), and users could hardly complete transactions at ideal prices.
3. Lack ability to resist extreme risks. Although it is common to ridicule the “pulling the net” of centralized exchanges, it is clear that the top centralized exchanges, such as Binance, have stronger solvency. Except for mechanisms, the solvency of decentralized exchange only depends on cash reserves of insurance funds and foundations, which is questionable. The risk of oracle attack also exists.

3.2 Competitive Landscape of Projects

3.2.1 Basic market landscape & competitors

Strictly speaking, the biggest project in synthetic asset field is MakerDao. However, Synthetix uses synthetic assets to cut into derivatives trading, and thus we do not take MakerDao as a competitor to Synthetix.

On the racetrack of decentralized derivatives trading:

1. “Pure” on-chain derivatives trading projects as represented by dydx, mcdex, perpetual, opyn, and ddx remain one category. The current performance of ETH has a greater impact on this part of the project than SNX. In terms of TVL, volume, liquidity and other aspects, except for dydX, they all have a long way to go. Even for dydX, trading volume falls far behind Synthetix.
2. Cut-in synthetic assets remain another category. In addition to Synthetix, Mirror, Linear, UMA and some others have gained scale. UMA is also a very interesting project. As its direction is more focused on the long tail market other than derivatives trading, we do not see UMA as a competitor to SNX.

We chose mirror, with the highest transaction volume and token market value, for comparison.

Synthetix vs mirror

Mirror runs on terra chain other than ETH chain, and is closely coupled with the other tokens Luna /UST in the terra system. It takes time to explain subtle and complex relationship between them. Here we only briefly introduce mirror as:

Mirror (Token MIR) is a synthetic asset protocol running on the Terra public chain. Users can generate synthetic assets (mAssets) by over-collateralizing UST (a stablecoin anchored to 1USD) or further generate new mAssets by overmortgaging mAssets. Similarly, mirror also allows users to trade mAsset at the oracle price with no slippage. At present, mAsset mainly synthesizes US stocks corresponding assets, which also include a small amount of crypto synthetic assets such as BTC and ETH.

Comparision of TVL between Synthetix and Mirror.

Data source:https://www.tokenterminal.com/terminal/projects/synthetix

Data source:https://www.tokenterminal.com/terminal/projects/synthetix

Comparision of TVL between Synthetix and Mirror.

Data source:https://www.tokenterminal.com/terminal/projects/synthetix

The following includes the trading details of Synthetix and mirror, at around 11:00 on June 24th, in 24-hour period, respectively

Below are Synthetix’s trading volume in past one month and that of mirror in past three month, respectively

Ttrading volume for the past three months of Synthetix and Mirror, Data source: Official Website Data Statistics Module

We can see that there is some overlap in Synthetix and Mirror’s trading pairs, evidently demonstrating the characteristics of “Synthetix dominated by cryptocurrency class, and Mirror dominated by US equity assets class”.

Thanks to Terra Public Chain’s excellent function and mobility incentive policies, Mirror has seen rapid growth in TVL, which has now surpassed synthetix.

In terms of trading volume, we can see that: Mirror’s daily average volume stands at around $30 million, while Synthetix’s daily average volume is also around $30 million, with no significant difference between the two. While the majority of Mirror’s trading volume comes from MIR trading pair, with majority derived from the Terra chain. We believe that Mirror currently poses a substantial threat to Synthetix from a derivatives exchange perspective

Except for continuously launching Layer 2 trade and leverage, for Synthetix to address this threat, it seems that there is not much to do. As Kain puts it, “… To me it feels like Synthetix is in a similar place, we have to an extent been forgotten among all the amazing defi launches of the last year and have been in a holding pattern for almost a year as we worked with Optimism to get Synthetix launched on L2. Yet we are approaching a point where multiple releases will converge and we will finally have the protocol we have been trying to build for the last four years. It has been a gruelling and painful process but we are so close you can almost taste it. So there is some noticeable frustration within the community that this has not been translating to more awareness. I will never get sick of saying how poor information propagation is within crypto, even once everything above is delivered and implemented it will still take weeks or months before the wider defi community is aware of it. With crypto the key is patience, we have the will and the resources to keep delivering until it is impossible for anyone to ignore what we have built. You must not let frustration creep in, keep your head down and keep building.”

This may partially explain price trend of SNX since January.

3.2.2 Project strengths and weaknesses

Synthetix’s competitive advantages over other decentralized derivatives exchange projects are mainly:

1. Proven core product logic: dynamic debt pool;
2. First mover advantage in synthetic assets;
3. The reputation for quick response and high execution built up during the DeFi boom;
4. Support from top ventures and a motivated team.

Synthetix’s competitive disadvantages are mainly:

1. Irreconcilable conflict between protocol security and capital utilization rate: since the protocol mainly encourages the staking of SNX to provide liquidity, and the price of SNX fluctuates greatly, capital utilization rate has to be reduced to guarantee protocol security. At present, the mortgage rate of 500% and the liquidation line of 200% relatively guarantee the security of the protocol, but reduces capital utilization rate greatly. Considering factors such as the token model, we expect this conflict to remain irreconcilable for quite some time.
2. The understanding cost and adoption cost of dynamic debt pool model is high

3.2.3 Token Analysis

Currently, SNX is the only capture value token in this project. As mentioned above, SNX’s value capture in the ecosystem comes from: SNX incentives for staking above the officially recommended mortgage rate and transaction fee.

The initial ICO had a total of 100 million tokens, of which:

l 60 million for ICO

l 20 million for teams and consultants

l 12 million for foundations

l 5 million reserved for partnership

l 3 million reserved for market

In March, 2019, to incentivize the stake behavior of SNX holders, the token economy of the project underwent a major change. In 2024, the total amount of tokens will be expanded to 245 million.

Supply of SNX for year one to year six, data source: SNX official website

Note: “Year One “refers to the period from March 2018 to March 2019, currently having entered”Year Four”.

At the end of 2019, the inflation rate of additional supply would start to be smooth.

Currently, the total supply of SNX tokens is 227,477,432, with full diluted market cap of 2,710,001,373 USD. The current circulating supply is 114,841,533, with a circulating rate of 54%. The cirulating market cap is USD 743,769,087 , ranking 79th among all tokens.

Note: the above data from https://coinmarketcap.com/

3.2.4 Risk

We summarize the possible risks of Synthetix as follows, ranked according to impact:

• Regulatory risk

While regulation of centralized exchanges derivatives (such as the recent regulation of China) in sovereign states may be positive for SNX in the short term, the fact is that regulation remains biggest risk to Synthetix. In the long term, US stock synthetic asset trade is high prone to iron fist from the SEC. After all, to be a decentralized Bitmex, taking the risk undertaken by Bitmex is needed.

b. Oracle risk

In 2019 and 2020, reports about oracle attacks on Synthetix are common. In 2020, Synthetix have switched all of its oracle to Link. Although expected to be reduced, attacks against the oracle will remain a significant risk for the project in the long term.

c. Key functions launch delay /missing expectations

This includes the delay of lauch for the planned content of Synthetix itself, delay of OE, and upgrade of Layer2 experience missing expectation -excessive gap as compared to CEX derivatives trading experience, etc.

d. Risk of substitutes

While Synthetix has a first-mover advantage, the risk of being replaced by similar projects still remain, with decentralized derivative trading field lacking shovel-ready products and emerging new projects.

4. Preliminary valuation

4.1 Five core questions

What business cycle is the project in? In mature stage, or early and middle stage of development?

The project is in early stage of development, with some core functions not online yet. Product core logic has been successfully tested and PMF(Product/Market Fit) test is completed.

Does the project enjoy a solid competitive advantage? Where does this competitive advantage come from?

Competitive advantage of the project mainly include proven product core logic, first-mover advantage in the racetrack, as well as excellent team and investment institutions.

Is the medium to long term investment logic of the project clear? Is it consistent with the general trend of the industry?

The medium to long term investment logic of the project is clear, with the decentralized derivatives exchange capable to create a higher market capitalization, consistent with the general trend of the industry.

What are the major operational factors affecting the project? Are they easy to quantify and measure?

At this stage, the main variables are launch time and actual experience of Layer2 and leveraged trading. In the long run, the main variables will come from adjusting to regulatory systems of various countries. Amount of staking, trading volume, Open Interest and other core data would affect the above mentioned factors, all available on chain.

What is the project management and governance approach? What is the level of DAO?

At present, the project has basically turned to community governance, with DAO level leading various DeFi projects.

4.2 Summary of core logic of investment

Synthetix deserves active attention now for the following reasons:

1. As compared to centralized spot trading exchange (Uniswap) and centralized derivatives trading exchange (Bitmex), decentralized derivatives exchange racetrack enjoys huge market potential.
2. From industry, Layer2 brings greatest benefits to decentralized derivatives trading. With the launch of Arbitrum’s Mainnet and Optimism coming soon, Layer2 has finally come.
3. Synthetix’s core business logic, “Dynamic Debt Pools”, has been tested for more than two years and is proven with fact. With Dynamic Debt Pools mechanisms, Synthetix may realize “unlimited liquidity for unlimited trading targets”, with stronger network effects and easier “winner-takes-all”.
4. Synthetix’s core functions: Layer2+ leveraged trading will be online soon, expected to bring new business growth and valuations.
5. The system has four sub-projects likely to launch tokens and distribute tokens to SNX holders.
6. The team is aggressive and willing to take responsibility, achieving high project governance and community building level.

4.3 Valuation Evaluation

We take:

l Historical valuation comparison method to compare SNX’s current and past valuation

l Horizontal valuation comparison to compare SNX with other DeFi projects from the perspective of P/S and P/E

4.3.1 Comparison of historical valuations

We analyzed the data of SNX’s circulating market capitalization and transaction fees from February 2020 to now, and calculated its “circulating market capitalization /annualized transaction fee” according to its transaction fee each month.

Month

SNX circulating market cap

(million USD)

Transaction Fee

(million USD)

Annual transaction fee

(million USD)

Circulating market cap /annual transaction fee

(Dynamic P/S)

2021–06

Till 23rd

744

2.73

42.82

17.37

2021–05

1921

4.13

49.56

38.76

2021–04

2117

1.47

17.64

120.01

2021–03

2247

2.05

24.6

91.34

2021–02

2486

2.72

32.64

76.16

2021–01

1580

4.92

59.04

26.76

2020–12

652

2.35

28.2

23.12

2020–11

445

1.04

12.48

35.65

2020–10

406

0.40

4.8

84.58

2020–09

487

0.85

10.2

47.75

2020–08

514

0.55

6.6

77.88

2020–07

263

0.25

3

87.67

2020–06

198

0.067

0.804

246.27

2020–05

148

0.054

0.648

228.4

2020–04

126

0.11

1.32

95.45

2020–03

103

0.056

0.672

153.3

2020–02

164

0.021

0.252

650.8

Note: data from https://www.tokenterminal.com/terminal/projects/synthetix ,transaction fees taking all available data

From the above data, after the recent sharp drop, SNX’s monthly “negotiable market capitalization/annualized transaction fees” is below 20, lower than most times in history.

Therefore, we conclude from the historical valuation comparison method that the current valuation of SNX is: undervalued.

Of course, there is a possibility of being in bull market ever since the data has been available; in addition, SNX could take a higher valuation given a small scale. Given that, we compare the horizontal valuation within the industry in the following.

b. Horizontal valuation comparison

(As BitMEX has neither issued tokens nor go public, and derivatives trading volumes of Coinbase and Binance with market value data take low percentage in total platform trading volumes, we cannot compare SNX and centralized derivatives exchanges through horizontal comparison;)

Our horizontal valuation comparison mainly compares various DeFi protocols

If we take “circulating market capitalization/total income” as P/S (price-to-sales ratio) and “circulating market capitalization/protocol income” as P/E (price-to-earnings ratio), we get the following data.

An example of the difference between total income and protocol income: Uniswap’s transaction fees income is counted as “total income”, but the fees go entirely to the supply side (LP). As this income is not captured by the protocol or UNI token, it is not counted as “protocol income” for Uniswap.

Protocol

circulating market cap ($million)

Annuallized Total income

($million)

Annuallized Protocal income

($million)

P/S

P/E

Uniswap

9635

1611.48

-

5.98

-

SushiSwap

847

606.48

101.04

1.40

8.38

Aave

2512

336.84

18.84

7.46

133.33

Compound

1219

200.52

24.96

6.08

48.83

Maker

2074

122.76

122.76

16.90

16.90

Synthetix

732

38.88

38.88

18.83

18.83

Mirror Protocol

366

45.96

-

7.96

-

Note: Protocol income and token capture protocol revenue data are obtained from tokenternimal, and the annualized protocol income and token capture protocol income are deducted from annual value of protocol revenue and token capture value in last 30 days. The circulating market capitalization data are taken from CMC

We can see that from a P/S perspective, Synthetix’s valuation is not only the highest of the several DeFi protocols, but also greatly outnumbers that of Mirror. However, from a P/E perspective, Synthetix’s P/E valuation is much more reasonable as the transaction income is captured entirely by SNX holders. Meanwhile, Synthetix’s competitor Mirror currently pays all its transaction fees to the LP of mAssets-UST, with its token MIR unable to capture this income, making this data irrelevant.

Currently, except for protocol income, almost total income will be basically distributed to the supply side (LP in Dex, depositors in lending protocol), supply side revenue will definitely be reduced when the project distributes more income to the protocol. At the same time, more of original supply side users will be transferred to other protocols when other conditions are the same. Thus, distributing a higher percentage of income to protocol will reduce the total income of the protocol. Therefore, we expect that if Mirror also changes its fee allocation rule, its total income will decrease.

Therefore, according to the horizontal valuation comparison within industry, current valuation of SNX is reasonable.

Combining historical and horizontal valuation data, we believe that SNX is currently reasonably valued and slightly undervalued.