Educational Byte: What Are Synthetic Tokens in Crypto Networks?

Synthetic tokens are artificial, man-made tokens that mirror the price of another asset, like gold or a cryptocurrency, instead of representing the asset itself. They don't provide ownership of the underlying asset, but rather give investors exposure to its price movements. Unlike Real World Asset (RWA) tokens, which hold a direct correlation to a concrete asset, synthetic tokens only track the asset's price.

At the core of synthetic tokens are smart contracts, which establish the rules for creating and managing these positions. Collateral, often overcollateralized (meaning more value is deposited than the synthetic assets created), supports these positions. Overcollateralization helps manage risks created by price fluctuations and ensures the synthetic asset remains backed by collateral.

Oracles are crucial for providing precise price data, as crypto networks typically don't have this data native to them. Oracles act as data feeds, converting external information into on-chain data, allowing the smart contract to calculate values and maintain the synthetic instrument's alignment with its target.

Synthetic tokens offer several benefits and use cases. They allow investors to gain exposure to various assets or markets without the underlying asset moving on-chain, which is useful for commodities, currencies, stocks, and indices. Additionally, synthetic assets can interact with decentralized applications (Dapps), enabling developers to incorporate them into lending systems, exchanges, and other smart contract applications.

This composability enhances financial products' ability to interact with one another, rather than remaining in separate systems.

An example of synthetic tokens in action is Obyte's Pythagorean Perpetual Futures. These tokens track the prices of various assets, such as currencies, stocks, commodities, or other cryptocurrencies, using Pythagorean bonding curves and oracle-provided target prices. These futures are tokens that track external asset prices rather than represent ownership of those assets, making them synthetic assets.

They never expire, and their price mechanism adjusts toward the target reported by an oracle. Synthetic tokens can be seen as a broader concept than simply creating digital copies of assets. They transform price exposure into an on-chain, programmable instrument, opening new possibilities for building financial products around assets that previously remained outside distributed networks.