Four Ways To Generate Passive Income From Your Bitcoin
Unlike Ethereum and other smart contract chains, the Bitcoin you hodl cannot generate yield. Yes, Bitcoin has appreciated in price more than any other crypto or asset class over the last 10 years, but you cannot stake Bitcoin or invest it in DeFi - not directly at least. Playing the long game and waiting for Bitcoin to appreciate is a fine strategy - for most people.
But if you want to put your Bitcoin to work and are willing to take on some risk, here are four ways to generate income from your Bitcoin holdings – without giving up any of your Bitcoin. While all of these options carry some risk, they allow you to retain full control and get back 100% of the Bitcoin you invest.
The four strategies are:
Liquidity mining on Uniswap
Liquidity mining on THORchain
Lending your Bitcoin
Let’s get into it:
Mining Bitcoin is the original strategy for generating Bitcoin. In the early days, it was possible to mine hundreds of Bitcoin on any laptop. But since 2014, mining Bitcoin has required specialized ASIC hardware which today costs upwards of $10,000. Furthermore, the cost of electricity is the most important factor in the profitability of Bitcoin mining. Today, mining Bitcoin is only profitable in regions with below-average electricity prices.
Bitcoin mining is a high-risk game of high capital costs and long payoff periods. A crash in the price of Bitcoin price may make miners unprofitable to run for years at a time, by which time they become obsolete.
A much simpler way to earn Bitcoin is to mine other cryptocurrencies and get paid in Bitcoin. Nicehash offers a user-friendly tool for mining cryptocurrencies on a graphics card and getting paid for it in Bitcoin. Just about any gaming computer with a graphics card can be used f0r mining crypto, even if the return is low. For older graphics cards, the cost of electricity can exceed the value of the Bitcoin you earn, but this may be irrelevant if you need to heat your home. It’s also an anonymous and safe way to earn Bitcoin.
Once you are ready to scale, you can build custom rigs dedicated to crypto mining. Using a service like Celsius Network, you can take out a loan against your Bitcoin in USD to pay for mining equipment, and get 100% of the Bitcoin you loaned when you pay back your loan.
Liquidity mining on Uniswap
Uniswap is one of the top dapps (decentralized applications): a distributed application that uses smart contracts to facilitate swapping between different crypto tokens using an automated market maker. To perform swaps, Uniswap requires liquidity: assets lent to it by users. Uniswap pays a small percentage of each transaction to reward users for loaning their assets. This is called liquidity mining. Liquidity mining is always done as a 50/50 pair of the two assets being swapped: for example, Ethereum for USDC. The potential loss from doing so is called impermanent loss: the potential loss when the ratio of the price of the two assets is not stable. To earn yield on your Bitcoin, you would need to convert 50% to Wrapped Bitcoin and 50% to some other asset, like ETH or USDC.
To minimize impermanent loss, you can pair stable assets: for example USDT/USDC, which should maintain a 1 to 1 peg. But rewards for liquidity farming match risk, so stablecoin pairs have the lowest yield.
The strategy I recommend is to invest coins that you own anyway, and hold them long enough that impermanent loss is outweighed by the reward. Some options are WBTC/USDC or WBTC/ETH. With WBTC/USDC, you are giving up 50% of the appreciation in Bitcoin by holding 50% in USDC, but you are also sheltering 50% by holding it in USD. If you would hold dollars and Bitcoin anyway, this is a good strategy to make a profit from holding these assets. (See this calculator for potential profits and this calculator for losses due to impermanent loss.)
Providing liquidity on THORchain
THORchain is a liquidity network similar to Uniswap in that it allows swapping between assets, but it has some significant differences:
THORchain allows swapping between different chains, such as Bitcoin to Ethereum. No wrapping is involved. You can earn yield on native Bitcoin, not its wrapped (WBTC) version.
All THORchain asset pairs are against RUNE, the utility token. This means the assets risking impermanent loss are the staked asset and RUNE.
THORchain provides impermanent loss protection (ILP). The protection is phased in so that after 100 days you get 100% protection. However, because 50% of your pair must be RUNE, you are still exposed to its volatility.
You can provide single-sided liquidity, for example, by depositing Bitcoin only, and getting Bitcoin back when you withdraw. However, 50% of your Bitcoin will be converted to RUNE, so your ILP only protects 50% of your Bitcoin.
Uniswap has never been hacked, but THORchain has been hacked twice. Still, the losses from these hacks were relatively small and did not impede the overall growth of the platform.
THORchain is the blockchain and relies on other projects to provide dapp front-ends. THORswap is currently the most common frontend to THORchain.
So - is Uniswap or THORchain better? I think it comes down to what kind of impermanent loss you’re willing to tolerate - Bitcoin vs USDC/ETH or Bitcoin vs Rune. It’s a tough call, so a strategy of diversification may be best. There’s a calculator of the THORchain yield on Bitcoin - the current rate is 10% APY.
The THORchain protocol is very complicated, but THORswap makes investing your Bitcoin easy and supports the Ledger hardware wallet, which I strongly recommend over the other wallet connection options in THORswap.
The final strategy is lending your Bitcoin out using CeFi platforms like Celsius Network, BlockFi, or Nexo. These platforms will pay 1-6% APY for your Bitcoin. But how do these platforms make money on your Bitcoin, since Bitcoin itself is a non-producing asset? I believe that they use Bitcoin as collateral to borrow assets that they can earn a yield on, such as stablecoins and Ethereum. Then they invest the stablecoins in DeFi to do yield farming on various protocols.
When you deposit your Bitcoin to these platforms, you are loaning your assets to them in exchange for the promise of a dividend and the return of your principal upon request. I think this is the safest way to invest, but it has the downside of having the lowest return. The most popular networks have a high promotional rate for the first .1 to 1 Bitcoin, but it drops steeply after that, to around 1% - though the rates change weekly, and can be boosted in various ways.
Because of these promotional rates, using multiple platforms can be good. Note that due to SEC intimidation, Celsius, BlockFi, and Nexo all kicked out non-accredited US users from earning yield on new deposits this year.
I’ve tried all of the options described above (I wouldn’t recommend them otherwise) and I think they are all viable options for putting your Bitcoin to work.
Here are some guidelines to follow:
To minimize exposure to any one investment strategy or smart contract, diversify into multiple platforms.
All investments come with risks, so you should research them on your own, especially the concept of impermanent loss.
Never buy assets solely for the purpose of earning yield on them. You should understand their value proposition and believe in their fundamental value.
Always use a hardware wallet (Trezor/Ledger) with DeFi.
Double-check the contract you’re interacting with in MetaMask by viewing it on EtherScan.
Transaction costs and impermanent loss mean that you should plan to invest for at least a year before taking profits.
As always, just hit reply if you have any questions.