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The success of Synthetix also depends on the adoption of Optimism Ethereum in the DeFi ecosystem.
Title of the original text: “The Way of DeFi丨This article elaborates on whether Synthetix’s success or failure depends on Optimism is the right choice “
Written by: Messari Research
Synthetix is one of the largest synthetic asset platforms on the Ethereum platform, but the high gas fee of Ethereum makes it extremely expensive for users to trade synthetic assets on Synthetix and compresses SNX’s pledge income. The creation, exchange and trading of synthetic assets are all complex transactions, so Synthetix itself is a large gas consumer.
Fortunately, with the entry of Ethereum Layer 2, the Optimism Ethereum (OE) expansion solution can help Synthetix reduce gas costs by several orders of magnitude. Saving gas will create opportunities for pledgers to develop the foundation of synthetic assets, and also create opportunities for asset management agreements to earn fees for trading synthetic assets on behalf of investors. The Synthetix revenue model creates a positive feedback loop, and the performance improvements and cost reductions that OE brings will compound the benefits. If Synthetix can manage execution risks such as L2 migration and systemic risks such as Optimism adoption, then Synthetix will be positioned as one of the biggest beneficiaries of L2.
Synthetix rewards SNX pledgers through two sources of income-SNX inflation and sUSD transaction fees. Inflation is procedural and controlled by Synthetix DAO. Given that the total supply of synthetic assets is a function of the amount of SNX pledged as collateral, its purpose is to incentivize the liquidity of Synthetix. Pledgers will receive SNX rewards once a week based on the inflation schedule and the proportion of pledgers in the SNX pool on Synthetix. Pledgers can collect their rewards at the end of each period, and must escrow their new SNX for one year in the agreement. Transaction fee rewards are also controlled by the DAO. Last year Synthetix.Exchange averaged 41 bps per transaction. In each period, the pledger will earn sUSD transaction fees based on its SNX pool share without the need for third-party custody.
The current APY of SNX pledgers is 31.2%, which includes 30.3% of SNX inflation gains and 0.9% of sUSD transaction fees. Inflation gains require DAO decisions to change, so they remain stable. However, the transaction fee yield requires more Synthetix.Exchange transactions to grow.
The transaction reward model is designed to promote a positive SNX pledge feedback loop, thereby increasing the platform’s pledge or creating more synthetic asset capacity. As the total value of the pledged SNX increases, the Synthetix pledge also increases. More synthetic asset transactions generate more transaction fees, which are rewarded to SNX pledgers. As SNX pledge becomes more and more attractive, the demand for SNX increases, which also increases the Synthetix pledge rate and increases the synthetic asset capacity. Synthetic asset trading creates the following motivations for the value of SNX:
Synthetix on Optimism
The Ethereum gas demand for each transaction depends on the transaction complexity and priority, not the economic value. Therefore, when the transaction value decreases, the gas cost will increase accordingly. At the protocol level, the table below shows that Synthetix’s gas cost is less than half of the protocol transaction fee.
Optimism greatly reduces gas costs. According to the average transaction volume, when ETH is US$2,391 and Gas price is 125 Gwei, OE can save more than 99% of gas costs in all synthetic asset transactions. Based on the current trading volume, this represents an additional $6.3 million worth of synthetic asset traders. Applications such as dHedge, 1inch and Zapper.fi manage user assets by aggregating investment and trading opportunities across the entire DeFI. These one-stop shops have developed complex strategies, which also require heavy gas costs. The amount of gas savings on OE increases with the increase in transaction frequency rather than transaction volume, so asset managers can increase their share as users and transactions increase.
Among several Ethereum Layer 2 expansion solutions, Optimism Ethereum (OE) is the current favorite. OE uses a side chain that works in parallel with the Ethereum main chain. After completing a batch of transactions, Rollup will propose a new state to the mainnet. For example, they summarized and notarized the transaction. Rollup uses the Solidity programming language to make it compatible with the Ethereum Virtual Machine (EVM), which simplifies the process of porting Layer 1 projects to Layer 2.
In October 2020, the Synthetix trading competition test for OE saved more than $10 million in gas costs in nearly 104,000 transactions. So far, OE can handle nearly 300 times the number of smart contract calls, or nearly 2,000 basic transfers per second. OE also provides a source of Synthetix’s value, throughput and cost-effectiveness.
Synthetic asset management
When routing through Synthetix.Exchange, transactions between synthetic assets will benefit both traders and SNX pledgers. First, traders get zero slippage prices. The Synthetix pricing formula allows direct conversion between synthetic assets based on the price provided by the oracle. Since slippage usually increases with the increase in transaction volume, the benefits of zero slippage for larger transactions are greater than the benefits for smaller transactions. Second, SNX pledgers earn fees from synthetic asset transactions conducted on Synthetix.Exchange. A dapp that can route synthetic asset transactions through Synthetix.Exchange by using the Synthetix “exchange” function can order synthetic asset transactions outside of Synthetix. Zero slippage will attract a large number of transactions, which will encourage trading dapps to use Synthetix.Exchange for transactions between synthetic assets. More synthetic assets on Synthetix will increase the transaction fee return provided to SNX pledgers.
In September 2020, Synthetix started their “Trading Volume Plan” to incentivize developers to establish synthetic asset-to-synthetic asset transactions on their platform. Applicants for the approved plan can earn a rebate at 75% of the 0.3% Synthetix agreement transaction fee during the plan period.
The success of this plan prompted Synthetix to expand the plan in December 2020, and it is possible to expand it indefinitely. As of April 6, 2020, Synthetix Twitter account announced that participants of the March 2021 trading volume plan will receive a rebate of $24,000. Curve leads with a transaction volume of $118,000, followed by dHedge, 1Inch and Enzyme platforms.
Synthetix has added a “Trading Volume Plan” report on its platform statistics page, which shows that current and future participants have room for expansion. One month before the writing of this report, the exchange trading platform incurred USD 1.4 million in synthetic asset trading fees. Excluding Synthetix.Exchange and Kwenta, these two local platforms were not eligible to participate in the transaction volume plan, and participants incurred a transaction fee of $701,000. During this time, less than half of synthetic asset transactions were completed directly on the Synthetix platform. This represents nearly 50% of the synthetic transaction market share that the asset management agreement can obtain from Synthetix. This will enable Synthetix to optimize for the realization of asset management transactions, rather than for platform users and individual users.
Migrating to OE will bring execution risks to Synthetix. The community must strike a balance between the user experience and the unstable technical requirements brought about by the complexity of the platform. Kain Warwick, the founder of Synthetix, pointed out in a blog post in October 2020 that OE simplifies this process by building with Solidity. Without extensive rewriting of smart contracts, Synthetix can allocate resources for protocol stability and user experience. Although complementary, the core functions of SNX pledge and synthetic asset trading use different economic principles, so users need different incentives to use Synthetix during the migration. Synthetix plans to start trading on the OE Mainnet before July 2021. The Layer 2 SNX pledge has been fully implemented on OE, which will split the pledge between L1 and L2. The agreement team reduces risk by merging collateral and debt pools. When users and their assets migrate from L1 to L2, this can enhance the economic stability of the agreement.
Synthetix must also reduce the risk of OE adoption. Several L2 extension solutions will be launched in 2021, and as dapps are launched on these products, they will compete for users. Kain Warwick, the founder of Synthetix, acknowledged the risks in an OE update article: “It is not enough to choose the right design and trade-offs-we must also optimize for the solution that others are most likely to choose.” Fortunately, For Synthetix, they are not alone. In March 2021, Uniswap announced that V3 will be released on OE in July 2021. As the leading Ethereum DEX, Uniswap’s decision may push the direction of L2 adoption towards OE. Synthetix developers chose OE to increase transaction throughput with the lowest unit cost and lowest technical complexity. Synthetix is fully committed to OE, so its success depends on the adoption of OE.
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