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How to earn passive income with Bitcoin?

How can Bitcoin investors and hodlers earn interest on Bitcoin? How to invest Bitcoin to earn passive income?

How to earn passive income with Bitcoin? Many hold Bitcoin – some of them are long time holders, the others are seeing only the last “up-and-down” cycle. Some of them would like to earn additional revenues on their holdings. This leads to the question – how to earn interest in Bitcoin holdings without selling?

This article will analyze:

  • What is Bitcoin?
  • As next, we look at the dominance of Bitcoin in the crypto market
  • Then, we look at the ways to earn interest with Bitcoin in the custodial solutions
  • After that, we analyze how to earn interest with Bitcoin in DeFi

What is Bitcoin?

Bitcoin is a decentralized digital currency that exists on the Bitcoin blockchain.

Bitcoin network is based on the following key innovations:

  • Using a distributed peer-to-peer database to store financial assets and to protect them via the cryptographic algorithms
  • Solving the “trust issue”, that’s the situation where multiple writers want to change the same database, but not all of these writers can be trusted. For example, some writers would like to modify the history of the data – that’s not possible thanks to the Bitcoin innovation.

The Bitcoin blockchain can be compared to a general ledger, where all transactions between the addresses are cryptographically secured and immutable.

Key use cases of Bitcoin are the following:

  • Payments – doing payments from any Bitcoin wallet to any other blockchain address
  • Store of Value or “digital gold” – gold has served for the last 5’000 years as a store of value. In the last 50 years, the central bankers have tried to discredit the store of value function of the gold. For example, gold has been called “economic relict” or Warren Buffet declared having gold pointless because gold does not pay any dividends or interest.

It seems that the critics of gold have missed the last 5’000 years of history – there has always been base-money and credit-money. Bitcoin has all the characteristics of the base-money and the capability to replace gold as the base-money.

There are several additional utilities of Bitcoin. For further information please have a look at the blog articles Bullish Case for Bitcoin Price Valuation and A Bullish Case for Bitcoin Valuation 2.0.

Bitcoin Dominance in the Crypto Market

Bitcoin has established himself has the key cornerstone of the crypto market. One way to monitor this is via the Bitcoin Dominance Chart, which shows the ratio of the Bitcoin market capitalization to the total crypto market capitalization. The following chart shows the Bitcoin dominance from 2013 till now:

Bitcoin dominance
Bitcoin dominance (source: https://coinmarketcap.com/charts/ )

Bitcoin dominance is at the moment at 65%. Because of this, we can anticipate that most of the crypto investors have some amounts of Bitcoin. This leads to the question of how to earn interest on Bitcoin?

Earn interest in Bitcoin in custodial lending

One of the possibilities to earn BTC interest is via the custodial lending systems. The key platforms are:

  • BlockFi
  • Celsius Network
  • Crypto.com

These platforms offer crypto wallets, where the users can deposit their Bitcoin and other crypto assets. These platforms have access to their user’s private keys and therefore they can access the assets in these wallets. These systems will pool the client assets and will lend them to institutional investors (hedge funds, institutional investors). The interest from institutional borrowers is distributed back into the client wallets.

This business model is very similar to the prime brokerage business model in traditional finance – it’s about pooling assets and serving the institutional investors (either for trading or hedging purposes).

Coinmarketcap published as well as the current Bitcoin interest. At the moment of writing (21.06.2020) it was the following:

Bitcoin lending interest
Bitcoin lending interest (source: https://interest.coinmarketcap.com/)

If an institutional investor is borrowing Bitcoin, then his interest is short selling – the speculation that the Bitcoin price will decline. The investor will pay interest to the lender and he will return the asset at the end of the loan term. If a higher interest rate is offered, then this implies institutional investors are speculating on the decline of Bitcoin price. And vice versa.

Earn interest in Bitcoin in margin lending in crypto exchanges

Another possibility to earn crypto interest in Bitcoin is via the crypto exchanges. The users have to register their accounts and to deposit the funds. As next, they can lend their Bitcoin on the crypto exchanges via the margin lending – their counterparties are the traders, which borrow Bitcoin in the anticipation that the Bitcoin price will fall.

These traders borrow Bitcoin, they sell it on the exchange and they pay daily interest or fixed-term interest for their loans. Trader’s assets and positions are used as collateral against these borrowings – if the price of Bitcoin would increase instead of declining, then the trader’s assets will be liquidated to cover the obligations to the borrowers.  However, if the price of Bitcoin will decrease, then the trader will buy back the Bitcoins at the end of the loan term, will return them to the borrower, and will earn a nice profit on this trade.

The crypto exchanges have automated this user experience for both the borrowers and the lenders. Because of the crypto exchanges trading volume and the simplicity to use the system

The oldest exchange, which offers this functionality is the Bitfinex. Here are the annualized Bitcoin lending rates:

 

Bitfinex BTC lending rate
Bitfinex BTC lending rate (source: https://bfxrates.com )

These are daily interest rates – where the interest rate is set every day. This chart shows a spike between May 2020 and April 2020. That’s the indication, that there was increased short selling of Bitcoin at that time and the traders were willing to pay high interest for borrowing Bitcoin (they speculated that the Bitcoin price will fall).

Earn BTC interest with the DeFi (Decentral Finance)

The third way to earn Bitcoin interest is via the DeFi. DeFi is based on the Ethereum, however, there is WBTC – wrapped BTC – which is mapping the Bitcoins into the Ethereum network.  The beauty of WBTC is that it’s an ERC20 token, which makes it easily usable in the DeFi infrastructure.

How could one get WBTC? The user would need to convert his BTC via the WBTC partners and the users would receive WBTC ERC20 tokens, which he could then lend via the crypto platforms.

In the case of custodial lending or in case of exchange based margin lending the user doesn’t control his asset – it’s the platform provider, which will control the asset. The users are transacting on these platforms with IOU’s (I Owe You). If the user is using the WBTC in the DeFi platforms then it’s the user’s asset – there is no intermediary platform controlling the asset.

SmartCredit.io Approach

SmartCredit.io will add WBTC as an underlying for lending and as collateral. The lenders will be available to monetize their WBTC’s without losing control over them.

The key advantage of SmartCredit.io is low collateral ratio – borrowers can borrow 2x to 3x times more on the same asset basis compared to other platforms. The lending market is driven by the borrowers, the lenders follow the borrowers (and not vice versa). That’s why having a low collateral ratio makes the platform attractive for both borrowers and lenders.

Summary

The article described three ways to earn interest via Bitcoin.

  • Via the custodial lending – the operating platforms control users asset, pools them and lends them in the prime brokerage business model style
  • Via crypto exchanges margin lending – the operating platforms control users asset, user can either passively or actively lend his asset to the traders
  • Via WBTC lending in DeFi – user will convert his Bitcoin into the wrapped Bitcoin and will lend it on the DeFi platforms

Additional information

For more information check out the related articles from the SmartCredit.io blog:

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