UMA's new synthetic token tracks ETH/BTC ratio, a novel attempt to rescue DeFi, backed by serious academia

No price? UMA? Synthetic tokens? This may be a bit confusing at first. In essence, this development offers a novel price feed mechanism. Furthermore, it also contributes to the advancement of decentralized finance (DeFi).

What are UMA and Synthetic Tokens?

In simple terms, there is a platform called Universal Market Access (UMA) on the Ethereum smart contract that allows you to create custom financial products using cryptocurrencies.

For example, through UMA, you can create a virtual currency that tracks the price of the Chinese yuan, or you can create a virtual currency that tracks the price of Tesla stocks (or even Facebook). The platform even gives an example where you can create a lottery game based on the S&P500 index, distributing winnings based on its performance.

The virtual currencies mentioned above are generated through UMA's Synthetic Token Builder, which is what we refer to as Synthetic Tokens.

However, it's not as simple as creating virtual currencies out of thin air. To create custom Synthetic Tokens, you must collateralize a certain amount of "Dai". Dai is a virtual currency pegged 1:1 to the US dollar, issued based on collateralized Ethereum, and is gradually transitioning to a multi-asset collateralized form by the tech company Maker.

Betting on Ethereum as the Winner! Or You Can Be the Banker

On May 21st, UMA introduced a new Synthetic Token: ETHBTC, which tracks the price ratio between Ethereum (ETH) and Bitcoin (BTC). If ETH outperforms BTC, the token value will increase; if ETH underperforms, the token value decreases, and this Synthetic Token will settle on August 1, 2020.

The game is that when it was launched, the price was 0.02 Dai (equivalent to $0.02). Assuming that the ETH/BTC ratio on the settlement date is 0.03, the Synthetic Token will have appreciated, and buyers can redeem it for 0.03 Dai.

You can also choose to be the banker. Creating ETHBTC does not require permission; anyone can collateralize a certain amount of Dai through open-source smart contracts and allow others to buy your ETHBTC Synthetic Tokens.

Currently, on the popular decentralized cryptocurrency exchange platform Uniswap V2, you can already obtain ETHBTC Synthetic Tokens.

"Priceless" Cryptocurrencies?

What this product emphasizes is "Priceless," not in the sense of being invaluable, but in not requiring data supply on the blockchain, meaning no need for price supply.

Typically, Synthetic Tokens require an Oracle to track the price of the collateral, monitoring whether the smart contract has sufficient collateral value. This can lead to potential issues due to centralization of data sources, resulting in single points of failure. We have seen decentralized finance incidents in the past manipulated due to this, such as the bZx incident.

Priceless Synthetic Tokens do not rely on Oracle price supplies to execute smart contract liquidation but offer a new liquidation mechanism. "Liquidators" can determine smart contract collateral adequacy using off-chain data (outside the blockchain). When disputes arise, Oracles are used to resolve them, reducing Oracle usage and potential single point of failure risks in DeFi.

If this is all a bit confusing, think of these Synthetic Tokens as an experiment that allows certain mechanisms on Ethereum to reduce some financial risk by moving towards complete decentralization.

We reached out to Lee Hsuan, founder of the Taiwanese blockchain company Portto, for his thoughts on the matter. He stated, "What it's doing is similar to Synthetix (another Synthetic Token platform). I will be watching closely. As for reducing Oracle usage, it's like many decentralized applications that claim to be decentralized, but users don't really care."