Bitcoin, the first and most well-known crypto asset, does not include native staking functionality like most PoS (Proof-of-Stake) blockchains. This means that directly “staking” Bitcoin to earn rewards isn’t already possible in the way it is for other assets. Fortunately, non-custodial and decentralized solutions have recently been created that give Bitcoin holders access to innovative ways to earn yield on their assets. This guide explores some of the various ways to earn yield on Bitcoin. It looks at the risks involved and the evolving space of Bitcoin yield generation.

Understanding Bitcoin Staking

What is Staking?

Staking, as it is commonly understood in the cryptocurrency space today, means contributing to the security and operations of a Proof-of-Stake (PoS) blockchain. In PoS systems, users “stake” their tokens with a validator, who is responsible for validating transactions and securing the network. In exchange for contributing to the network, they are rewarded with staking rewards — often denominated in new tokens. Bitcoin, on the other hand, uses a Proof-of-Work (PoW) consensus mechanism, which is based on mining not staking.

Differences Between Staking and Mining

The primary distinction between staking and mining can be found in their respective methods of validating transactions and protecting the network. In the case of Bitcoin, mining simply means competing to solve arbitrary mathematical puzzles in order to create a new block of transactions on the blockchain. This extensive process takes a lot of computing power and energy to do so as well. Staking, in contrast, is where you lock up a predetermined number of cryptocurrency coins to help verify transactions. Stakers are chosen at random to validate transactions, with an emphasis on those who stake a higher amount of cryptocurrency to their network. The more cryptocurrency they stake, the higher their likelihood of being chosen.

Earning Yield on Bitcoin

While Bitcoin doesn’t have native staking mechanisms like PoS networks do, there are multiple ways for BTC holders to earn yield. Each of these approaches comes with different levels of risk and complexity.

Centralized Lending Platforms

One popular way to do so is by lending Bitcoin via centralized lending platforms. These platforms simply serve as the intermediaries, matching borrowers and lenders on opposite sides of the platform. Bitcoin holders can deposit their BTC on these platforms and earn interest by lending it to borrowers. Support Bitcoin lending through centralized lending platforms like Binance and Nexo. The platforms themselves and what they offer are always evolving. Minting yields on BTC via centralized lending platforms has offered net annual returns of between 4–8% in BTC terms.

Wrapped Bitcoin (WBTC) on Ethereum

Wrapped Bitcoin (WBTC) is an ERC-20 token on the Ethereum blockchain that represents Bitcoin. Each WBTC token is backed 1:1 by BTC held by a centralized custodian, BitGo. This enables Bitcoin holders to take part in the Ethereum based DeFi ecosystem and gain access to thousands of ways to earn yield. WBTC holders earn interest in Ethereum. As a general rule, interest is paid out on a daily or monthly basis. This serves as a new potential avenue for Bitcoin holders to earn yield on their assets.

Bitcoin Layer-2 Solutions

Bitcoin layer-2 solutions, like the widely publicized Lightning network, are protocols developed atop the Bitcoin blockchain to increase its scalability and usability. Many of these solutions have unlocked yield generation opportunities for Bitcoin holders. Networks such as Babylon and Stacks are examples of Bitcoin-related networks that facilitate yield generation.

Utilizing Centralized Lending Platforms for Yield

Step-by-Step Guide

  1. Choose a reputable platform: Research and select a centralized lending platform that supports Bitcoin lending and has a strong security track record.
  2. Create an account: Sign up for an account on the chosen platform and complete the necessary verification steps.
  3. Deposit BTC: Transfer your Bitcoin to the platform's designated wallet address.
  4. Lend your BTC: Choose the terms of your lending agreement, such as the interest rate and lending period.
  5. Earn yield: Receive interest payments on your lent Bitcoin, typically distributed daily or weekly.

Pros and Cons

  • Pros:
    • Relatively straightforward and easy to use.
    • Potential for consistent yield on Bitcoin holdings.
  • Cons:
    • Custodial risk: The platform holds your BTC, making you vulnerable to hacks or insolvency.
    • Counterparty risk: The borrower may default on their loan.
    • Regulatory risk: The platform may face regulatory scrutiny or be shut down.

Earning Yield with WBTC on Ethereum

Overview of WBTC

WBTC is an ERC-20 token that represents Bitcoin on the Ethereum blockchain. It opens up the entire world of Bitcoin-enabled DeFi taking place on Ethereum. WBTC is backed 1:1 by BTC held in custody by BitGo, an audited custodian.

Benefits and Risks

  • Benefits:
    • Access to Ethereum DeFi: WBTC allows Bitcoin holders to participate in lending protocols like Aave, provide liquidity on exchanges like Curve, and engage in yield farming opportunities.
    • Potential for higher yields: DeFi protocols on Ethereum may offer higher yields compared to centralized lending platforms.
  • Risks:
    • Custodial risk: BitGo holds the underlying BTC, posing a risk of hacks or insolvency.
    • Smart contract risk: DeFi protocols are vulnerable to smart contract bugs or exploits.
    • Bridge risk: The process of wrapping and unwrapping BTC involves bridging between blockchains, which can be vulnerable to attacks.

Exploring Bitcoin Layer-2 Solutions for Yield

Key Features of Layer-2 Solutions

Bitcoin layer-2 solutions have focused on increasing Bitcoin’s scalability and introducing new functionalities. Other layer-2 solutions allow ordinary Bitcoin holders to start earning yield by locking their Bitcoin into smart contracts with different mechanisms. Bitcoin holders can receive competitive staking rewards of 5%-20%. This minimal-risk investment does wonders for maximizing their Bitcoin reserves, while increasing the overall robustness of the system.

Innovative Mechanisms in Layer-2 Protocols

Innovative mechanisms within these layer-2 protocols include staking. In this process, Bitcoin holders can “stake” their BTC to participate in the network’s activities and receive hot rewards.

Analyzing the Coinbase Bitcoin Yield Fund (CBYF)

How CBYF Works

Coinbase’s fund to earn yield on bitcoin holdings. The strategy of the fund can be multifacted including but not limited to lending, staking (using layer-2 solutions) and/or funding DeFi protocols. The exact strategies used by the fund can differ based on the state of the market and regulatory demands.

Potential Benefits

There are special risks that go along with generating yield on Bitcoin (BTC). Unlike Proof of Stake (PoS) staking, it typically involves third-party services or layer 2 solutions that come with custodial and liquidity risks.

  • Diversification: The fund diversifies its yield-generating activities across multiple strategies.
  • Professional management: The fund is managed by experienced professionals with expertise in cryptocurrency investments.
  • Accessibility: The fund provides an accessible way for Bitcoin holders to earn yield without directly managing complex DeFi strategies.

Understanding the Risks of Earning Yield with BTC

We know the cryptocurrency market is very unpredictable, and Bitcoin value shifts substantially by the minute. This volatility can affect the book value of your yield-generating assets and the income you generate.

Market Volatility

Security concerns stem from the custodial risks posed by centralized platforms and custodians that control BTC. These funders risk losing their money to insolvency, hacks, or because they are shut down by regulators.

Security Concerns

Potential developments in the market include the growth of Bitcoin layer-2 solutions, which could unlock new opportunities for yield generation. Finally, the creation of more advanced DeFi protocols on Ethereum would further up the ante in terms of yields available to WBTC holders.

Future Trends in Earning Yield with Bitcoin

Potential Developments in the Market

We get it, the regulatory landscape for crypto is always in flux. A shifting regulatory landscape has the potential to affect not only the availability, but the legality of many yield-generating strategies.

Impact of Regulatory Changes

With earning yield on Bitcoin becoming more accessible, it’s important to understand the risks involved. Select either WBTC on Ethereum and centralized lending or Bitcoin layer-2 solutions. Whichever way you choose to go, do your homework and have proper risk management practices in place to protect your investments.

Earning yield on Bitcoin is becoming increasingly accessible, but it's crucial to understand the risks involved. Whether you choose centralized lending, WBTC on Ethereum, or Bitcoin layer-2 solutions, thorough research and risk management are essential to protect your investments.