What Are the Risks Associated with Trading Synthetic Assets?
The primary risks include smart contract risk, such as bugs or exploits in the code that could lead to loss of funds. Oracle risk is also significant, as a manipulated or faulty price feed could cause incorrect liquidations or pricing.
There is also collateral risk; if the underlying collateral is volatile, it could lead to cascading liquidations during market downturns. Finally, there is peg risk, where the synthetic asset may lose its correlation to the underlying asset due to market pressures or failures in the stabilization mechanisms.
Glossar
Regulatory Risks
Oversight ⎊ Regulatory risks within cryptocurrency, options trading, and financial derivatives stem from evolving jurisdictional clarity and the potential for retroactive application of rules impacting market participants.
Faulty Price Feed
Feed ⎊ A price feed is a data stream provided by an oracle that supplies real-time market prices to smart contracts, enabling the calculation of asset values for derivatives and lending protocols.
Synthetic Assets
Construction ⎊ Synthetic assets represent on-chain financial instruments whose value is derived from an underlying reference asset, without requiring direct ownership of that asset; this decoupling is achieved through the use of smart contracts and collateralization mechanisms, enabling exposure to a diverse range of markets including equities, commodities, and other cryptocurrencies.
Oracle Front-Running
Exploitation ⎊ Oracle front-running, within decentralized finance, represents a form of market manipulation where an entity leverages privileged access to pending transaction data to execute trades before those transactions are confirmed on the blockchain.
Incorrect Liquidations
Anomaly ⎊ Errors in the automated engines used to close out insolvent positions can lead to the unauthorized termination of healthy accounts.
Cascading Liquidations
Trigger ⎊ Cascading liquidations initiate when an asset’s price declines sufficiently to breach the liquidation price of leveraged positions, particularly prevalent in cryptocurrency lending and derivatives markets.