DeFi Is a Ticking Bomb, Thanks to Innovative Collateralization

2021 is coming to an end, and DeFi’s top lineup is mostly made up of synthetic asset platforms (SAPs). Any platform allowing users to synthetics or derivative values which are tied to existent assets through complete real-time is known as an SAP. Synthetics usually represent different types of products globally, taking out the price until oracles can provide a consistent price feed – whether it’s a commodity, stock, or crypto asset.

As a result, SAPs can connect the bridge between the upcoming platforms in DeFi and conventional finance, giving access to investors to bet on available assets right from the preferred Blockchain environment. SAPs are expected to be crypto’s next significant growth accelerator, as they are decentralized and run on the layer one platform of Ethereum. However, unlike with sound money and verified artwork,  safe ownership and decentralization are just half of the problem, when it comes to collateralized lending. 

In conventional forms of finance, collateralized debt instruments are the most valuable financial assets, with a total value of almost $1 trillion. In order to ensure an individual receives the loan amount, the debtor presents collateral that gets locked up with creditors. In case the value of the debtor’s collateral declines, the creditor can assume for the possession also to liquidate the available collateral depending on the value it has in the market.

A novel collateralization mechanism will take DeFi by storm as 2022 dawns and crypto enters a new year. Users will be allowed to burn collateral to mint synthetics at an equal ratio rather than locking excess collateral into a contract. That means consumers get out exactly what they put in — dollar for dollar, sat for sat, one-to-one — and they’ll never be liquidated.

A native token with an elastic supply is the main component that underlies such a paradigm. There is little advantage to be felt when a user burns an SAP’s native token to mint synthetics for the first time. However, when this user burns synthetics to mint again, native tokens on the way out, SAP’s burn-and-mint protocol is activated.

Any discrepancies between the user’s original burnt collateral and minted synthetics will be handled by the protocol, which will either marginally enlarge or contract the native token’s supply to make up the difference.

The burn-and-mint collateral approach, a radical new paradigm, eliminates the downsides of liquidations while maintaining the capital efficiency and price parity that make synthetics so unique. As number crunchers continue their hunt for profits in the coming year, the capital of the mass crypto market will transfer to platforms that use various versions of burn-and-mint procedures.

All eyes will be on liquidity management as the DeFi environment undergoes its next significant transformation. Deep liquidity is expected to be a significant component in SAPs’ ability to permit large-volume withdrawals from their ecosystems without causing undesirable volatility. Liquidity management will differentiate DeFi’s next iteration of blue-chip SAPs from those who do not make the cut on DeFi systems where collateral management has previously been an issue.