Synthetic Asset Vault

The foundational security mechanism where the total value of locked collateral exceeds the value of the issued synthetic assets. This creates a safety buffer to absorb price volatility and prevent undercollateralization. For example, a vault may require $150 in ETH to mint $100 worth of a synthetic stock token.

• Purpose: Mitigates liquidation risk and maintains peg stability.
• Collateral Ratio: A key parameter (e.g., 150%) set by governance or the protocol.

Vaults rely on decentralized price oracles (like Chainlink) to provide accurate, real-time valuations for both the collateral and the synthetic asset. This data is critical for:

• Calculating collateralization ratios.
• Triggering liquidations when ratios fall below a threshold.
• Maintaining the synthetic asset's peg to its target reference asset (e.g., gold, Tesla stock).

Automated processes that protect the system's solvency. If a user's collateral value falls below the required minimum collateral ratio, their position becomes eligible for liquidation.

• Liquidation Process: A portion of the collateral is sold (often at a discount) to repay the minted synthetic debt.
• Liquidators: Third-party actors are incentivized with a bonus to execute these liquidations, ensuring the vault remains overcollateralized.

Synthetic assets are not backed 1:1 by specific collateral but are claims against a shared debt pool. All minters share the system's collective debt and collateral.

• Risk Mutualization: Price fluctuations are distributed across all participants.
• Global Settlement: A failsafe mechanism that allows users to redeem their synths for a proportional share of the underlying collateral basket at oracle prices, settling all open positions.

The core user actions facilitated by the vault's smart contracts.

• Minting: Users deposit approved collateral to generate new synthetic tokens, increasing the system's total debt.
• Burning: Users return synthetic tokens to the vault to unlock their proportional collateral, reducing their share of the debt. This two-way mechanism controls the supply of synths in circulation.

Key system parameters are often managed through decentralized governance (e.g., token voting). This includes:

• Setting collateral types and their ratios.
• Adjusting liquidation penalties and thresholds.
• Adding new synthetic asset markets.
• Upgrading oracle integrations and contract logic.

A protocol on the Terra Classic blockchain that allowed the creation of mirrored assets (mAssets), synthetic tokens tracking the price of real-world stocks and ETFs. It used Terraswap LP tokens as collateral in its minting process via Mint and Short Farm vaults.

• Key Feature: Focused on synthetic equities (e.g., mAAPL, mTSLA).
• Collateral: Primarily UST and mAsset LP tokens, demonstrating a unique design for synthetic asset backing.

Synthetic vaults differ primarily in their collateral types and debt mechanisms:

• Pooled vs. Isolated Debt: Synthetix uses a shared global debt pool; others use isolated vaults.
• Collateral Type: Native tokens (SNX), stablecoins, or yield-bearing tokens (Abracadabra).
• Oracle Reliance: All systems are critically dependent on decentralized price oracles (like Chainlink) to maintain accurate asset pricing and prevent insolvency.

The primary risk is undercollateralization, where the value of the backing collateral falls below the required ratio to support the minted synthetic assets. This can trigger liquidation events or a global settlement.

• Oracle Failure: Inaccurate price feeds for collateral or the synthetic asset can cause improper liquidations or allow the system to become undercollateralized.
• Volatility Spikes: Rapid price drops in collateral assets can outpace the liquidation mechanisms.

The entire system depends on the security of its smart contracts and governance. Vulnerabilities can be catastrophic.

• Code Exploits: Bugs in the minting, redemption, or liquidation logic can lead to direct fund loss.
• Governance Attacks: Malicious proposals or token voting attacks could alter critical parameters (like fees, collateral ratios) or upgrade to malicious contracts.
• Integration Risk: Reliance on external protocols (e.g., DEXs for liquidity, oracles) introduces their failure modes.

Users face risks related to other participants and market depth.

• Liquidity Provider (LP) Risk: LPs in associated pools face impermanent loss and rely on arbitrageurs to maintain peg stability.
• Redemption Slippage: Converting a synthetic asset back to collateral may incur high slippage if liquidity is insufficient, effectively reducing its value.
• Counterparty Insolvency: In models with debt positions, the failure of large holders can increase the system's debt burden.

Synthetic assets rely on price oracles to track their underlying reference asset and maintain their peg.

• Oracle Manipulation: A manipulated price feed can be used to mint synthetic assets with undervalued collateral or to trigger unjust liquidations.
• Peg Divergence: The synthetic asset's market price may depeg from its intended value due to low liquidity, loss of confidence, or arbitrage inefficiencies, separate from the protocol's collateral health.

These instruments may attract regulatory scrutiny and are vulnerable to broader market contagion.

• Regulatory Uncertainty: Synthetic assets representing equities, forex, or derivatives may face legal challenges or restrictions in certain jurisdictions.
• Systemic Collateral Correlation: If vault collateral is highly correlated (e.g., mostly ETH), a sector-wide downturn can stress multiple vaults simultaneously, overwhelming liquidation systems.

Leading protocols implement specific mechanisms to manage these risks.

• Synthetix: Uses a pooled debt model with staking rewards and penalties (SNX) to incentivize overcollateralization and a decentralized oracle network (Chainlink).
• MakerDAO: For synthetic assets like DAI, uses stability fees, surplus buffers, and a PSM (Peg Stability Module) to manage the peg and collateral health.
• Abracadabra.money: Uses interest-bearing tokens (ibTKNs) as collateral, introducing additional yield and smart contract risk layers.

The foundational mechanism for securing synthetic assets. Vaults require users to lock overcollateralized assets (e.g., ETH, stablecoins) as a guarantee against the value of the minted synthetic asset. This creates a collateralization ratio (e.g., 150%), which acts as a buffer against price volatility. If the ratio falls below a liquidation threshold, the position can be automatically liquidated to maintain system solvency.

A critical piece of infrastructure that provides external, real-world data to the blockchain. Synthetic vaults rely on price oracles (like Chainlink) to determine:

• The value of the locked collateral.
• The price of the tracked external asset (e.g., Tesla stock, gold). This data is essential for calculating collateralization ratios, enabling minting/redemption, and triggering liquidations. Oracle reliability is paramount for system security.

A risk management process that occurs when a vault's collateralization ratio falls below a safe threshold (e.g., due to collateral value dropping or synthetic asset value rising). Key elements include:

• Liquidation engines: Automated systems or keeper networks that identify undercollateralized positions.
• Liquidation penalties: Fees paid by the vault owner, often distributed to liquidators as an incentive.
• This process ensures the synthetic asset remains fully backed, protecting the protocol and other users.

Close relatives in the synthetic asset family. Collateralized stablecoins (like DAI) are synthetic dollars backed by crypto collateral in vaults. Algorithmic stablecoins aim to maintain peg through algorithmic supply adjustments rather than direct collateralization. Synthetic asset vaults generalize this model, allowing the minting of tokens that track any asset's price, not just a stable currency.

Platforms that provide synthetic exposure through different architectural approaches. Examples include:

• Synthetix: A protocol-level debt pool where users mint synths against staked SNX, sharing collective collateral.
• Mirror Protocol: Created synthetic assets (mAssets) tracking stocks, using Terra stablecoins as collateral.
• dYdX/Perpetual Protocols: Offer synthetic leverage and perpetual swaps, though often with a different custody model than vaults.

The user's obligation within the vault system. When you mint a synthetic asset, you create a debt position denominated in that asset. The health factor (or collateral ratio) is a real-time metric calculated as (Collateral Value) / (Debt Value). This single number determines the safety of the position:

• Health Factor > 1.5: Safe.
• Health Factor < 1.1: At risk of liquidation. Managing this factor is the user's primary responsibility.