Synthetic assets

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"The term “synthetic asset” refers to a mix of assets that have the same value as another asset. Traditionally, synthetics combine various derivative products — options, futures or swaps — that simulate an underlying asset — stocks, bonds, commodities, indexes, currencies or interest rates.

For example, rather than purchasing a stock, an investment firm may purchase a call option and sell a put option on the same stock. The use of synthetic assets here allows the firm to make use of multiple financial vehicles rather than a single investment asset.

The high-end estimate for the value of all derivative contracts is upwards of $1.2 quadrillion — a number exponentially bigger than global real estate ($217 trillion), the global debt ($215 trillion), global stock markets ($73 trillion) and the world’s supply of gold ($7.7 trillion).

On one hand, derivatives can be used to help take price risk out of a variety of assets like commodities to debt. On the other hand, derivatives can promote and exacerbate market inefficiencies, encouraging a zero-sum game among traders rather than creating true market value. The use of derivative products allows investors to earn returns without a physical settlement, arbitrage trade, transfer risk and hedge against price fluctuations.

In practice, if an investor wanted to buy Google stocks worth $1,000 through Abra, the firm would peg $1,000 of the user’s BTC against the price of Google’s stock. If Google goes up or down, the equivalent amount of BTC will be added or subtracted from the user’s contract.

In the above example, the investor would essentially be taking a short position on BTC while taking a long position on Google, the hedged asset. Meanwhile, Abra would take a long position on BTC while shorting Google.

Decentralization grants open-access to a global community of investors. Before products such as Abra, Synthetix and UMA became available, only a select few institutional investors could access the global derivatives market. Now, anyone with a smartphone and an intermediate understanding of the synthetic asset underworkings can access these powerful investment vehicles."

"Synthetic assets are financial instruments that simulate another asset’s payoff. In that way, they are synthetic, not the actual asset, hence the name.

Any difference between synthetics and derivatives? Those names are often seen in the same context (e.g. Investopedia’s examples for synthetics and derivatives).

In our case, we are simply using derivatives as instruments that simulate other assets’ payoff and synthetics as derivatives that use a mix of assets/derivatives."