It may appear fairly simple for one to judge solely on face value and categorize the asset as a security or a financial product. Why it does sound like a derivative or a financial service, doesn’t it? Well, this common misconception occurs when one overlooks how a synthetic token actually operates, thereby misleading most to a quick judgment of its legal status. Simply stated, judging a book by its cover.
The synthetic token is a collateral-backed token. Its value fluctuates as per the tokens’ reference index. Synthetic tokens blends characteristics from prediction markets, futures markets, and collateralized loans.
Some examples of synthetic tokens would include-
- Synthetic real-world assets
- Synthetic cross-chain crypto assets
- Tracking tokens for various non-tradable indices
Simplifying it to ground-level, a synthetic is a token normally created on a blockchain to act as a pointer to the value of another asset. Ownership of a synthetic indicates the ownership of a “reference” to the price of the other asset instead of the asset itself. This means that neither the owner of the synthetic nor any linked party to the transaction may lay claim to the ownership on the asset referenced. However, what you do own is the collateral used to create the token. Generally, a synthetic asset is formed out of overcollateralizing another asset, for instance, ETH, to create relevant synthetic assets.
Therefore, what actually gets traded is the collateralized asset that is encapsulated into a token. The issuer of the token is simply what reference index to peg the token to. It could be a stock such as TESLA, or Disney Stock. It could also be the current market rate for 1 gram of gold.
The Over-collateralization Part
To pulp it down, a synthetic is similar to a stable coin such as USDC. Each USDC is purportedly collateralized by 1 USD. Thus, it points to a 1:1 collateralization. It may be a 1 to 1 collateralization due to the reference token’s value and the value of the collateral being in unison. Oftentimes, the collateralization greatly differs from the reference value such as ETH [collateral] and Tesla stock [reference point], in such cases, there must be over-collateralization to allow for volatility shift in (1) the reference value and (2) the collateralization value.
Security or Not?
Basically, synthetic is similar to a stable coin in some ways. A synthetic token simply dishes out a new unit of measurement of your collateral, which means, instead of measuring your ETH in ETH, you are now measuring your ETH in terms of Tesla stock. The difference may be cited in the following example: instead of saying that you are sending 1 ETH, you may say you’re sending 2 Tesla stock – when you’re still sending the ETH and not an actual Tesla stock.
The individual, in reality, is trading in digital currency with a value equivalent to a traditional asset. Thus, the digital currency trade merely bears equivalence to a unit value of some financial product or asset in the backdrop.
The trade of digital currency, in essence, makes for a logical and substantial argument to deem it a non-security token.
While the Australian crypto community seems confident that the argument would stay under Australian law, the actual outcome is yet to unfold.
Consensus, or Somewhat
As the speculation begins to take off, there has been a generous outpour of opinions among the crypto-aware. While some consider it outright security, there are others in tune with the ‘non-security’ status of the synthetic. Some others took a ‘depends’ stance. For example, a US start-up owner comments that whether security or not, will be use case dependent. This was a generally accepted opinion trailed by stating that it differs with jurisdiction. What is acceptable as per Australian law may not hold for the US and the SEC.