Bitcoin, the original and most well-known cryptocurrency in the world, recently hit a record $1.3 trillion market capitalization. Yet, it presents a paradox for its holders: it generates virtually no yield. This reality has fueled a search for creative alternatives. The long-term vision of the company is to turn Bitcoin from a “dead asset” into a productive element of investment portfolios.
Yield generation is inherently restricted in the architecture of Bitcoin, secured without smart contracts by its proof-of-work consensus mechanism. Unlike most other cryptocurrencies, Bitcoin does not provide any native staking rewards, resulting in holders having to jump through hoops to earn passive income. This poses an interesting hurdle, unlike the example of more traditional financial assets which usually produce a dividend or interest.
The Hunt for Bitcoin Yield
Sophisticated hedge funds have taken advantage of this zero-yield environment by deploying complex off-chain arbitrage strategies. Thus, these firms can hope to extract returns on the order of 5-20% simply by taking advantage of price differences between exchanges and markets. Yet for the average Bitcoin holder, these opportunities are still out of reach.
Bitcoin’s two-month futures contracts are now guaranteeing a return of just over 6% annualized. This profit is the result of a contango capture strategy, profiting from the disparity between futures contracts and the current spot price. Bitcoin remains trapped in a zero-yield environment for ordinary holders. What we hear from folks is that this is unsustainable, particularly given its colossal market cap.
DeFi's Role in Bitcoin Transformation
If Apple or Microsoft had to operate under the same set of constraints, the economy would soon see a massive revolution. The effect would be severe given their huge market capitalizations and lack of compensating returns for investors. Bitcoin's potential transformation from a zero-yield asset to a productive portfolio component could reshape the value proposition of decentralized finance (DeFi).
Bitcoin’s composability within DeFi opens doors to integrate yield-bearing real-world assets through Wrapped Bitcoin (WBTC). This bridge allows Bitcoin holders to leverage themselves into different DeFi protocols, potentially opening up a world of new yield-generation opportunities. Current returns remain modest.
Challenges and Limitations
In spite of all that promise, Bitcoin earns an average APY of under 1% on the vast majority of DeFi platforms. Even if lending demand wildly increases, flooding the pipelines in bull markets and briefly reaching 3-5% actionable rates, longer-term, persistent yields have proven evasive. This is largely due to borrowers rapidly paying back their positions or liquidations resetting the market equilibrium, eliminating long-term, steady returns.
Pairing Bitcoin with volatile assets in liquidity pools creates additional hurdles, most significantly, the threat of impermanent loss. This occurs when the prices of both assets in the pair move apart. Therefore, the overall value of the liquidity provider’s assets drops. When you’re combining crypto, especially Bitcoin, with things like stablecoins USDC your effective returns are typically cut in half. At an instant, you’ve increased your risk exposure two-fold.