Multi-Collateral Synthetics

The value of a synthetic asset is backed by a diversified pool of assets. The primary risk is correlation risk, where multiple collateral assets devalue simultaneously during a market crash, threatening the over-collateralization ratio. This can trigger mass liquidations. Systems must manage asset allocation and weighting to mitigate concentration risk and maintain stability.

Synthetic prices are entirely dependent on external price oracles. Key risks include:

• Oracle delay/latency: Stale prices can be exploited for arbitrage or cause incorrect liquidations.
• Data manipulation: Attackers may attempt to manipulate the oracle's price feed to drain the collateral pool (a flash loan attack vector).
• Centralization risk: Reliance on a single oracle creates a critical point of failure. Robust systems use decentralized oracle networks with price aggregation.

When a user's collateralization ratio falls below a threshold (e.g., 150%), their position is liquidated. In multi-collateral systems, a sharp drop in the value of one major collateral asset can trigger widespread liquidations. This selling pressure can further depress the collateral asset's price, creating a negative feedback loop or death spiral. Liquidation penalties and auction mechanisms must be designed to absorb this volatility.

The entire system operates via immutable smart contracts. Risks include:

• Code vulnerabilities: Bugs in the minting, trading, or liquidation logic can lead to fund loss.
• Upgradability risks: If the protocol uses proxy patterns for upgrades, admin key compromise could be catastrophic.
• Integration risks: Vulnerabilities in integrated DeFi protocols (e.g., lending markets used for collateral) can propagate through the synthetic system.

Counterparty risk is decentralized but present. The protocol's governance token holders control critical parameters like:

• Collateral types and their risk parameters (debt ceilings, liquidation ratios).
• Fee structures and stability mechanisms.
• Oracle selection and upgrade decisions. Malicious or poorly executed governance proposals can destabilize the entire system, representing significant governance capture risk.

Synthetic assets that track real-world equities, commodities, or fiat may face regulatory scrutiny. Key considerations:

• Securities regulation: Depending on jurisdiction, synthetics may be classified as securities, requiring compliance.
• Collateral re-hypothecation: The legal status of collateral pooled from global users is often untested.
• Sanctions compliance: Protocols must consider how to handle restricted jurisdictions, posing a censorship-resistance vs. compliance dilemma.

The collateralization ratio is the minimum value of locked collateral required to mint a synthetic asset, expressed as a percentage (e.g., 150%). It acts as a safety buffer against price volatility of the collateral. A higher ratio increases protocol security but reduces capital efficiency for minters. This ratio is dynamically enforced by the protocol's liquidation engine to ensure the synthetic asset is always fully backed.

Price oracles are critical infrastructure that provide the protocol with real-time, tamper-resistant price feeds for both the collateral assets and the synthetic assets being tracked. They are the source of truth for:

• Calculating collateral value and health.
• Determining the exchange rate for minting and redeeming synths.
• Triggering liquidations when collateral value falls below the required ratio. Reliability and decentralization of the oracle are paramount to prevent manipulation.

A synthetic asset (synth) is the on-chain token that tracks the price of an external asset, such as fiat currencies (sUSD, sEUR), commodities (sXAU), or other cryptocurrencies (sBTC). It is minted against locked collateral and can be traded, used in DeFi, or redeemed for the underlying collateral value. Synths are fungible and trade on automated market makers (AMMs) within the protocol's ecosystem, providing deep liquidity for price discovery.

In a pooled collateral model, all minters share a collective debt pool representing the total value of all synthetic assets in circulation. When a user mints synths, they are assigned a proportional share of this global debt. Their debt share fluctuates based on the aggregate performance of all synths in the system. This design socializes volatility risk and eliminates the need for 1:1 collateral pairing, but it means a user's redemption value depends on the entire portfolio's performance.

The liquidation mechanism is an automated process that protects the protocol's solvency. If a minter's collateralization ratio falls below the minimum threshold (e.g., due to collateral value dropping), their position becomes eligible for liquidation. A liquidator can repay a portion of the outstanding synth debt in exchange for the collateral at a discount. This penalty incentivizes minters to maintain over-collateralization and ensures the system remains solvent without requiring manual intervention.

Protocols often incorporate a staking mechanism where users can lock the native governance token to earn rewards. These rewards are typically generated from the fees collected by the system, such as:

• Exchange fees on synth trades.
• Minting and redemption fees. Stakers may also be responsible for providing price oracle data or participating in governance, creating a synergistic relationship between system security, utility, and token economics.