Synthetix had another quarter of strong growth in product usage, with volume and fees both up over 10% from the previous quarter. Synthetix Perps added 32 new markets in Q3, now offering liquidity on 74 different underliers.
With revenues for the quarter higher and the SNX token price lower, yield for stakers annualized over 12% through the quarter.
Trading fees accounted for 46% of staker earnings in the third quarter. OP incentives ended on September 6, leading to a fall in volumes at the end of Q3 and a shift in the earnings mix. In the last month of the quarter, trading fees accounted for less than 30% of staker earnings.
V3 is nearly feature complete and a testnet trading competition has begun on Perps V3 on Base with mainnet launch expected in November or December. Meanwhile, Synthetix founder Kain has pitched a new front end for Synthetix while Kwenta and Polynomial continue to grow.
Primer on Synthetix
Synthetix is a decentralized synthetic asset issuance and liquidity protocol that allows users to trade synthetic cryptocurrencies, fiat currencies, and commodities. Each synthetic asset tracks the price of an external asset through the use of Chainlink, Pyth, or Uniswap V3 TWAP oracles. Users can either trade in spot or in perpetual futures markets for synthetic assets. SNX is the native protocol token, responsible for governance as well as the primary collateral that backs the liquidity of the network. SNX can be staked as collateral for sUSD, the Synthetix stablecoin, which can be traded on Synthetix for any other synth (sAsset). The DAO uses a novel V3 Governance Module (V3GM), which has councils of appointees voted on by SNX holders.
Volume on Synthetix rose again in Q3, reaching an all-time high of more than $13 billion. The product has now facilitated trades for nearly 15,000 unique wallet addresses since launching in December 2022. After the incentives ended this September, Synthetic Perps DAUs averaged 316 daily active users.
Using OP rewards is a unique network incentive, as the cost of funding user acquisition doesn’t dilute or reduce the runway for SNX asset holders. As expected with a large incentive scheme, there were likely some inflated numbers during the period. However, the product still performed without a hitch, and volume market share in the 24 days after incentives ended was nearly 50% higher than the 24 days before they began.
SNX stakers earn SNX inflation rewards and trading fees in sUSD, which are burned from the debt pool. In Q3, SNX stakers earned 5.4% more than Q2 in USD terms (measured daily), with a steady makeup of 46% from trading fees in Q3 versus 47% from trading fees in Q2. The small change in composition is less concerning than the steeper trend in the last month of the quarter of trading fees making up a smaller share of earnings. More reliance on inflation as a source of income for stakers increases the reflexivity of the token, which can increase volatility and thus risk for stakers managing their exposure versus the debt pool. The claim periods for the two earnings types differ as well, with SNX rewards requiring a 1-year escrow versus trading fees that are burned weekly.
The new product design continues to work well in insulating LPs from directional exposure and isolating yields. Synthetix Perps utilize dynamic funding rates and a unique price impact function to achieve LP delta neutrality. In Q3, average daily open interest increased to over $100 million from just under $70 million in Q2, while average daily LP exposure fell from 2.4% to 1.3%. The average exposure will likely continue to fall as market makers build more efficient ways to take advantage of the designs in Synthetix Perps that protect LPs.
A brief case study of a large liquidation during a market downturn on August 17, 2023, showcased the output of the Synthetix Perps mechanism design for LPs. At 12:44:59 AM UTC, a large ETH long was liquidated, removing over $25 million in long exposure from Synthetix OI. This position represented nearly 65% of ETH_Long exposure at the time. The liquidation left LPs with a net long exposure of almost 14,000 ETH, or over $25.6 million. Within 20 seconds, that exposure was cut to $10 million, and within 32 seconds, or 16 OP blocks later, the exposure was under $5 million at roughly 2,000 ETH.
The Perps design is intended to empower market makers to balance OIs on Synthetix. As a result, there is a reduced burden on LPs to actively hedge. This case study shows one recent success of that design. As time goes on, market makers will likely get more sophisticated and better at taking advantage of the incentives in the design and thus become even more efficient at reducing risk for LPs. While LP risk will not be totally reduced, the cost to LP should continue to fall, given normal market conditions.
Staking SNX continued to be a productive business in Q3’23, with average and median daily yields increasing roughly 50 bps from Q2. As of September 30, SNX stakers with a 500% collateral ratio are earning a 12% annualized yield YTD from trading fees and SNX inflation rewards. These yields do not account for SNX’s performance versus the debt pool or hedging costs.
Market volatility in August drove trading volumes higher while the SNX token sold off with the market, driving yields for stakers to around 20% for seven straight days. The end of OP incentives and a quieter market environment at the end of the quarter brought yields to their lowest of the year, below 8%. The yield from trading fees alone has averaged 5-6% in 2023, and in Q3 it fell within that range despite ending the quarter under 2%.
Inflation remained below 5.5% in Q3’23. In April, Synthetix changed its inflation schedule by adjusting the target staking ratio response function. The staking ratio is the amount of SNX staked as a percent of the total amount outstanding. With SCCP 294, inflation will remain unchanged (currently 325,445 SNX each week) within a 12% band of the 70% target staking ratio. If the staking ratio moves below 58% or above 82%, inflation will increase or decrease by 10% each week. SNX on Optimism now accounts for over 33% of the total circulating supply, rising from 29% at the start of the year.
Despite Q4’23 looking like a heavy escrow relative to the subsequent quarters, it will be significantly smaller compared to the previous two. Up to 10 million SNX will complete their 1-year escrow in the fourth quarter after nearly 50 million SNX were in Q2 and Q3 of 2023 combined. The stable inflation of ~325,000 SNX weekly should make this a much less interesting metric in 2024.
On the other side of escrowed SNX are vested SNX. These are the SNX tokens that have actually been claimed and released from escrow. Doing so requires a combination of time (1-year lockup), staker health (can’t be liquidated), and stakers claiming their earnings. During escrow, SNX rewards can be staked to compound earnings, though they cannot be claimed until after the escrow period.
Over the last two quarters, no more than 54% of the SNX tokens that completed their 1-year lock-up actually vested to be claimed. The number is likely lower given there is no expiration for/on vesting escrowed tokens; thus, the amount we measure vesting each week could include tokens that completed escrow more than a year prior. In brief, circulating tokens actually increase much slower than the escrow schedule would suggest, likely due to stakers leaving the earned SNX staked (it can be staked while in escrow) as well as liquidations or staker health.
While the number of active stakers is up 14.9% in 2023, almost all of the work was done in Q1. Q3’23 saw only 431 new active stakers on Synthetix, with 339 of those coming on the Layer-2 instance. The debt pool shrunk by 6.3% in Q3’23, led by the Ethereum instance falling by $5.95 million to under $75 million.
Stakers are encouraged by the DAO to hedge their debt pool exposure. When SNX stakers mint sUSD, they receive debt shares, which represent their share of the debt pool. Stakers that didn’t hedge their exposure to the debt pool or SNX price would be up roughly 50% on the year (assuming daily rebalancing to the 500% collateral ratio). The performance is primarily driven by a 37 percentage point outperformance by SNX versus debt shares along with ~12 percentage points from trading fees and SNX rewards. In the third quarter, unhedged stakers were flat as earnings balanced a slight underperformance of SNX versus debt shares.
Qualitative Analysis
Synthetix V3 Update
The Synthetix V3 system has come a long way and is now largely feature complete, with mostly minor changes waiting for release pending the approval of the Spartan Council (SC). The most anticipated recent development is the launch of the Perps V3 testnet competition, which will carry a prize pool of $15,000, 15 KWENTA tokens, and exclusive NFTs. This competition will serve as a crucial test for the Perps V3 mechanism ahead of the mainnet launch. Before the competition, there’s some detail work being done to enhance Perps V3, with a preliminary audit revealing minor points of attention. An L1 Perps market is being developed, targeting integrators and large traders who are less concerned with the gas costs.
After V3, the next big development priority is executing the cross-chain pool synthesis, which is a key pillar in the Synthetix endgame as the DeFi liquidity layer. Chainlink’s release of Teleporters using CCIP is a step in the right direction, but it only goes halfway in allowing Synthetix to write to other chains. Proposed by Synthetix Core Contributors, ERC-7412 is a standard that enables protocols to read data from other chains on-demand. The ability to both read and write cross-chain is necessary for pool synthesis to work.
The last key development is tied to the migration of assets, both from L1 to L2 as well as from V2x to V3. Currently, SIP-237 was proposed to enable debt migration from Ethereum to Optimism, but a more general L1 to L2 solution is desired. For the migration to V3, it is unlikely for OI caps to be increased within the next few weeks. Once the DAO is ready to move liquidity in earnest (and knows where it wants to move it), it can shift inflation incentives from V2 to V3. For both migrations, the team recognized the need for a friendly UI. The earliest full-scale launch could be by November or December.
In summary, Synthetix is gearing up for its V3 launch with a series of technical improvements, cross-chain functionalities, and community-driven decisions to ensure a seamless migration and enhanced user experience.
Market Share and Winning the Consumer
Synthetix Perps OP incentives began on April 19 with 10,000 OP rewarded in the first week. Beginning May 10, the weekly rewards increased to 300,000 OP (Note: Rewards were halted the week of May 31 for the Bedrock upgrade). More rewards also came from Synthetix front ends like Kwenta, Polynomial, Decentrex, and dHedge.
Large incentives tend to make it difficult to distinguish between organic and incentivized demand. To add clarity, the Optimism team put together a helpful dashboard that tracks many user metrics during the incentivized period. Synthetix’s own Gunboats also built a dashboard primarily to compare the fees earned with the incentives paid during the reward period.
Incentives ended on September 6, and since then, volumes have fallen, resulting in more claims that the protocol’s success was simply because of the subsidies. Having incentives on perp DEXs is not a novel idea by Synthetix, let alone a novel idea in acquiring customers for any marketplace. The canonical example for this is the ride-sharing wars between Uber, Lyft, and peers, where billions of dollars were spent as customer acquisition costs.
Going back to 2022, dYdX paid out $197.3 million in rewards to incentivize users. Those numbers are down substantially, but incentives continue for both traders and market makers. With help from its incentives, dYdX has maintained a roughly 60% market share in the perp DEX market (Note: Although dYdX could be considered a hybrid because of offchain order matching, we included it because of the self-custody of assets). In addition, GMX likely benefited from ARB airdrop farming, even if it didn't do direct incentives. Its volumes and market share have yet to recover since the airdrop.
Now at the end of Q3, Synthetix has completed an incentive program that increased market share substantially, and new competitors await. The nascent protocols Vertex and HMX are already dropping tokens for early users while Arbitrum Odyssey is returning to incentivize usage for protocols there.
Optimism and Arbitrum have huge war chests left, and dYdX still has a healthy treasury as well for its V4 launch hopefully coming this year. The point is, the incentives game likely will not end soon and neither will the mercenary capital that it attracts.
Synthetix is clearly a real player in the Perps game. It offers a battle-tested product, and it can support huge volumes and OI. Its accrual mechanism and LP risk design are first class. That said, Synthetix will still need to offer more to attract sticky users.
Enter Infinex: how to win the sticky consumer. Now that Synthetix has proven it has a good enough infrastructure and product to build on, it is time to build for the user experience. While incentives will likely be a large part of staying in the battle, it will take a best-in-class UX to win the war. There have already been huge successes from Kwenta and Polynomial on this front, and those teams are still shipping. Kain, the founder of Synthetix, is also entering the UX race with Infinex, an experience equivalent to centralized exchange trading, utilizing Synthetix for execution. One of Synthetix’s best features is that anyone can build a UX on it to access the liquidity and provide a service to traders — given that the infrastructure is good enough.
Synthetix seems to be taking the opposite direction compared to dYdX, though both with the same end goal. Along with their incentives, dYdX has what many would argue is the best UX for perps trading. Now, it has to find a way to decentralize the infrastructure and accrue value to the asset, which are likely the main goals of V4.
Optimism and the Synthetix team reaped rewards from their incentive spend that went beyond their market share increasing. More importantly, their product was battle-tested, and their designs proved rigorous and sustainable. Asset holders enjoyed higher yields as well, and soon, the market will show what it is willing to support while fees are lower. Meanwhile, teams building or looking to build a best-in-class perps front end can now confidently choose a backend liquidity and execution protocol to support their product.
Closing Summary
The explosion of trading on Synthetix Perps continued in Q3, and the design has greatly benefited both traders and stakers. Volumes and fees were up, with inflation leveling off, delivering low double-digit yields to SNX stakers. After the OP incentives program ended in September, volumes and fees fell, while yields for stakers shifted to being dominated by SNX inflation. The Synthetix V3 feature rollout continues as the team develops a more modular and composable platform, with an imminent launch on Base and cross-chain pool synthesis on the horizon.
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Before joining Messari as a Senior Research Analyst, John worked in Equity Derivatives on the buy-side and sell-side for over five years. He studied macroeconomics and markets for almost a decade. Now, John spends time thinking about token design, DeFi protocols, and governance.
Before joining Messari as a Senior Research Analyst, John worked in Equity Derivatives on the buy-side and sell-side for over five years. He studied macroeconomics and markets for almost a decade. Now, John spends time thinking about token design, DeFi protocols, and governance.
