Introducing SynthChain, The Synthetix Application Chain

Jackson
June 14, 2024

What is Synthetix?

Synthetix is a decentralized liquidity provisioning protocol built on Ethereum and Optimism, the Layer 2 scaling solution built on Ethereum. Synthetic assets, and associated products, are collateralized by stakers via Synthetix Network Token (SNX), which are then locked in a staking contract enabling the issuance of synthetic assets (synths). This pooled collateral model allows users to perform conversions between synths directly with the smart contract, avoiding the need for counterparties. This mechanism solves the liquidity and slippage issues experienced by DEXs.

Synthetix liquidity powers a range of derivatives and on-chain financial instruments such as perpetual futures, options, parimutuel markets, and more across EVM chains. You can learn more about the two types of synthetic assets (Spot/Perpetual) that protocols will integrate to create on-chain derivatives here.

The Synthetix Protocol does not operate any user-facing front-ends, which allow users to trade. Instead, it serves as a backend liquidity provisioning tool to a growing ecosystem on Optimism consisting of Curve, Aelin, Thales, Lyra, Polynomial, Torus, dHEDGE, and Kwenta.

Current State of Web2 / Centralized Exchanges (CEX)

  • Current Web2 applications and CEX’s have simple, single points of access
  • Users aren’t bothered about underlying networks, so user experience and execution speed are crucial to transactions
  • Deposits to CEX’s are network-agnostic as long as its supported by hot wallets and users don’t need to worry about underlaying databases or protocols

Current State of Liquidity Providers (LPs)

  • Liquidity fragmentation across all the different blockchains is a challenge. Bootstrapping liquidity on different chains is strenuous and the depth of the liquidity directly affects performance and experience of derivative markets.
  • LPs prefer simplified liquidity provisioning through either a Ethereum Layer 1 or a unified liquidity pool on a Layer 2 rollup, instead of moving collateral between chains to isolated pools which is cumbersome and technical.

SynthChain

Introducing SynthChain, the dedicated application chain (app-chain) where Synthetix state changes must be pushed for settlement. Make SynthChain the home of the central Synthetix system, with other chains becoming satellites, and using cross-chain messaging for synchronization. Optimism, the Layer 2 rollup has been chosen as the base for SynthChain.

Optimism’s vision of the Superchain is a horizontally scalable network of chains that share security, a communication layer, and an open source development stack. A permissionless system for deploying new chains to a shared network opens the door to massive scale, novel applications, and a new revenue model that rewards application developers for the fees their chains generate, and rewards protocol developers for the public goods they create. The Superchain is a modular development stack that is fast, simple, built to last, and will serve as a public good by utilizing the revenues generated to fund the public goods that enable the chains tools.

By selling blockspace on Synthchain to process all Synthetix transactions, the ETH transaction fees collected by the App-chain sequencer are redistributed to SNX stakers or utilized in a buyback and burn model.

Daily Fee Calculations

Based off of current transaction volumes from Defillama, this will generate:

  • $10 million in app-chain fees annually as on-chain perp grows and the number of users grow, this figure increases
  • Operating an app-chain costs ~$1k per day which can easily be paid for by the app-chain fees generated
  • With a daily network fee revenue of $26k, the daily network profit would be $25k+
  • Growing user base and transactions in a 10x scenario could bring in $100m in blockspace fees per annum.
Rollup appchain economics

User Flow of the App-Chain

  • Traders add the new network once into their wallet where trading will occur
  • Collateral is locked by traders on their preferred chain and can then be loaned trading margin on the app-chain
  • Seamless onboarding will be available for traders onto Synthetix perpetuals by depositing into the margin contract
  • Cross-chain messaging verifies the settlement on the original deposited margin contract
  • Margin deposit contract deployed on ETH Layer 1 and supported Layer 2’s to take custody of the collateral
  • sUSD PNL settlement/redeeming could occur by burning or minting on the ETH Layer 1 or unified liquidity pool, verified by cross-chain messages

Pros of a App-Chain

  • Most liquidity is either on ETH Layer 1 and Optimism/Arbitrum Layer 2 rollups
  • Debt pool shows Layer 1 and Layer 2 combining cross-chain liquidity works
  • Only requires liquidity pools for sUSD to be on ETH Layer 1 / one major Layer 1
  • LPs should be incentivized with the fee yield to bridge a secure decentralized chain to LPs
  • LPs are more sophisticated and are likely to be okay with bridging capital and liquidity to the most liquid chain
  • Traders require the best trade execution and finality. Not competing with other applications means Synthchain can maintain a better execution environment during high price volatility and liquidations

A potential idea for liquidity is to have a GMX/Gains like GLP liquidity token representing a share of the liquidity pool for LP. Price discovery of the liquidity token and fungibility allows liquidity (SNX/ETH) to be used as collateral on lending and leverage vault products on Synthetix.

Cons of a App-Chain

  • Security is only as strong as your weakest link.
    • The weakest link in the Layer 2 space is the upgrade keys which is a primary point of centralization for all rollupts as of this moment. If upgrade keys were to be compromised, all deposited assets in their respective Layer 2 would be at risk. There is a detailed path to decentralization for Optimism here with a TLDR below:

SynthChain would inherit the decentralization roadmap of Optimism’s sequencer mentioned above and would have no additional trust assumptions

Synth Chain is a step towards a unified, efficient, and economically promising ecosystem for Synthetix. By creating this app-chain, the chain can maintain a better execution environment during high price volatility and liquidations which is crucial for finality and trade executions for perpetuals and its traders on Synthetix.

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