A synthetic stablecoin is a type of cryptocurrency designed to maintain a stable value, similar to traditional stablecoins. Instead of being backed directly by fiat currency or other tangible assets, synthetic stablecoins are backed by a combination of crypto assets. They use financial engineering techniques to maintain their stability. These mechanisms often involve collateralized debt positions (CDPs), algorithmic controls, or decentralized finance (DeFi) protocols.
Definition and Explanation
Synthetic stablecoins aim to achieve price stability through smart contracts and collateral management. Hence they typically utilize a mix of cryptocurrencies and algorithms to peg their value to a stable asset like the US dollar. The primary goal is to provide the benefits of stability without relying significantly on traditional financial systems, making them more decentralized and resistant to censorship.
Examples of Synthetic Stablecoins
DAI (MakerDAO):
DAI is a decentralized stablecoin on the Ethereum blockchain that maintains its value by being collateralized by various cryptocurrencies deposited into smart contracts on the MakerDAO platform.
Mechanism: Users lock in collateral (e.g., ETH) to generate DAI, ensuring its value remains stable.
sUSD (Synthetix):
sUSD is a synthetic stablecoin that mirrors specifically the value of the US dollar. It is part of the Synthetix ecosystem, which therefore allows the creation of synthetic assets.
Mechanism: sUSD is backed by SNX tokens staked as collateral and maintained through an algorithmic system.
LUSD (Liquity):
LUSD is a stablecoin on the Liquity platform, which aims to provide decentralized borrowing on the Ethereum blockchain.
Mechanism: LUSD is minted by depositing ETH into the Liquity protocol, which furthermore uses a novel stability mechanism based on over-collateralization and liquidation triggers.
VAI (Venus Protocol):
VAI is a synthetic stablecoin on the Binance Smart Chain (BSC) created by the Venus Protocol. It is designed to maintain a 1:1 peg with the US dollar.
Mechanism: VAI is generated by using collateral assets deposited into the Venus Protocol, therefore offering a decentralized approach to stablecoin issuance.
Summary
Synthetic stablecoins offer stability in the volatile crypto market. Hence they leverage collateralized assets and algorithmic mechanisms, providing decentralization benefits. However, they come with risks like smart contract vulnerabilities and market fluctuations of underlying collateral.