Borrowing/Lending and Derivatives are Key Pillars of Bitcoin Yield
The BTCFi landscape is taking shape
The Bitcoin ecosystem is quickly changing.
My last post outlined how Bitcoin had arrived, and that Bitcoin’s next phase will be about finance, with Bitcoin as the foundation.
This post builds on the following broad assumption: if Bitcoin becomes as important as many think, people will want to earn a yield on that Bitcoin.
Two compelling sources of Bitcoin yield are borrowing/lending and derivatives, as Tyler from TYR Capital outlines in the post: The Future of Bitcoin Yield.
Let’s dive in.
Lending and borrowing in DeFi: the Bitcoin collateral use case
Borrowing against Bitcoin is in high demand. And the primary reason to borrow against Bitcoin is to earn a yield on stablecoins.
There is not much demand to borrow Bitcoin (it’s too risky). So, there isn’t a robust market to lend out Bitcoin to earn a yield. Most of the borrowing/lending activity is posting BTC as collateral to get dollars.
In short, the most active BTC-related lending isn’t lenders giving out BTC, it’s borrowers posting BTC to access stablecoins, and lenders earning yield on those stables in a collateral-backed, risk-managed structure. - The Future of Bitcoin Yield
I believe the demand for this use case is essentially unbounded. Using assets as collateral for debt is one of the most basic foundations of finance. This is traditionally a strategy that wealthy people (with assets) use. But this is where crypto makes things interesting. DeFi is giving more people the ability to do this — and without the need for lawyers, fancy contracts, or negotiations of terms. It’s a simple click of the button in an application.
Importantly, using Bitcoin as collateral won’t always be used to just earn a yield. This use case is more basic, like allowing people to borrow against their Bitcoin to start a business or pay for life expenses.
So, I believe “Bitcoin borrowing and lending” will be an unbounded use case (Aave is climbing the ranks of the biggest banks in the world).
The popularity of the use case is simple: it gives people liquidity without taking the tax hit of selling (or missing the upside of the underlying asset). And it can also give people leverage (a risky but important strategy if done correctly). Finally, Vitalik (creator of Ethereum) more or less wrote that lending/borrowing is the foundation of Ethereum DeFi.
Here’s an example of how this is working in practice. IXS recently shared its BTC yield product.
They write: “BTC holders pledge collateral, receive USDT, deployed into our regulated fixed income RWA Tokens.”
Put in simple terms, IXS takes out a loan against the Bitcoin and then deploys that in fixed-income products (like corporate debt or treasuries).
The math is simple — you take out a loan against your Bitcoin, and you deploy those dollars into low-risk yield opportunities like treasuries or corporate debt. Of course, the challenge is earning enough yield to pay back the loan without taking on too much risk.
Another example — a large vault on Morpho is lending out stablecoins to people who post BTC as collateral. Those who post BTC as collateral are able to get leverage on their BTC.
This strategy is, of course, risky as leverage is involved. There have been blow-ups in the past, and there likely will be more in the future.
Bitcoin Yield from Bitcoin Volatility (An Introduction For Non-Traders)
The Future of Bitcoin Yield article touches on Bitcoin L2s. However, it’s clear they believe it’s still too early to really focus on Bitcoin L2 yield sources like BTC liquid staking tokens. (Important nuance — borrowing/lending and derivative strategies as discussed in this post are already happening on Bitcoin L2s like Stacks).
When we see a project offering a higher yield than ~2% APY, we often find that it 1) has very little TVL, 2) is generating off-chain yields, or 3) is paying the user a subsidy. - The Future of Bitcoin Yield
Instead, the article focuses on derivatives (futures/options) as the true source of yield on Bitcoin.
Most people’s eyes gloss over when they start reading about derivatives, options, and futures. If you’re not an active trader (I’m definitely not), it’s just not something you need to know or care about.
But as I’ve been exploring Bitcoin yield, I’ve learned that Bitcoin’s mindshare, liquidity, and volatility give it a unique advantage — traders love to trade Bitcoin (with leverage).
And because traders love Bitcoin, you can harness that activity into yield.
The Future of Bitcoin Yield makes the critical point:
Yield on BTC exists because there will always be speculators and demand for leverage, and people are willing to pay to get leverage.
This is the summary of the argument for the best way to get a yield on BTC — people are willing to pay to get leverage on Bitcoin. So, you can build “structured products” that take advantage of people’s willingness to pay to get leverage (this is where the yield comes in).
Let’s walk through an example of this — ”the basis trade”
The basis trade is simple. Buy spot BTC, short BTC futures. You pocket the premium futures usually trade at over spot, regardless of BTC’s direction.
Here’s an example.
Buy 1 BTC spot, priced at $100,000.
Short 1 BTC 3-month future, priced $105,000.
The futures premium is $5,000. This premium is the critical part of the strategy.
Futures prices tend to be higher than spot prices (called contango) because traders seeking long exposure on Bitcoin with leverage will do this through futures contracts. There is a lot of demand for this (levered long exposure to Bitcoin), so futures tend to trade above spot — typically 80-90% of Bitcoin’s history. Why do traders use futures contracts? Futures are a clean, simple way for traders to get leveraged exposure to Bitcoin (without borrowing spot BTC).
Next, wait three months until the futures contract expires. For example, 3 months later, the price of BTC is $120,000.
1 BTC purchased at spot is now worth $120,000 (a $20k gain)
1 BTC 3-month futures shorted at $105,000 settled at $120,000 (a $15k loss).
Profit: $5,000
Alternatively, 3 months later, the price of BTC is $80,000, for example.
1 BTC purchased at spot is now worth $80,000 (a $20k loss)
1 BTC 3-month futures shorted at $105,000 settled at $80,000 (a $25k gain)
Profit: $5,000
Result: You always pocket the $5,000 premium, regardless of BTC’s direction.
This is just one of the many structured products used to earn a yield on Bitcoin.
The Future of Bitcoin Yield sums it up:
All of the above strategies share in that they are harvesting bitcoin’s inherent volatility. Real BTC yield is driven by others paying to take risk - and this is the crux of how BTC is becoming a productive asset without needing to lend it out.
Where this is going (and how to take advantage of it)
These structured products aren’t necessarily complex if you are a trader. But if you’re not, they take experience, risk management, account setup, and more. In short, normal people don’t want to do this type of activity — they have other skills.
In the past, these strategies were only available to sophisticated players. You had to have a relationship with a fund, and there was probably some sort of minimum allocation amount and lock-up period.
However, the world is changing, and access to these products is being democratized through DeFi (and also ETFs).
Let’s look at some examples.
Hermetica and Ethena:
Hermetica and Ethena wrap the trade described above into a token that can be purchased by anyone with an internet connection (with a slight nuance — they use perpetual futures rather than dated futures; however, the economics are generally the same).
From Hermetica’s transparency dashboard — the system is backed by Bitcoin.
But they’re able to issue a token (USDh) that is stable in dollar terms since Bitcoin is completely hedged (Long Bitcoin + Short Perpetual Futures = No price exposure to Bitcoin).
Finally, they can pay users the funding rate. So, Hermetica users earned around 7% APY by staking the USDh token.
There is a critical caveat for most instances of Bitcoin yield from derivatives — most trading activity takes place on centralized exchanges. So, builders have to harness the yield from Bitcoin trading activity offchain and then bring it back onchain. Hermetica shows this via the graphic below.
With Hermetica and Ethena, you give up your exposure to the Bitcoin price. However, we’re starting to see similar products that maintain Bitcoin exposure. For example, MAX BTC and Re7’s BTC Yield Strategy. I expect we will see more of these in the future.
Neutral Trade
Neutral trade is taking advantage of a similar dynamic. The header of their website explicitly calls out the promise of bringing hedge fund strategies to the masses.
ETFs
Roundhill Investments has a Bitcoin Covered Call strategy.
The covered call strategy is another very popular structured product that funds commonly use. Here’s an explanation from TYR Capital:
Covered Calls - involves selling options at a strike price higher than spot, while also holding the asset to deliver if exercised. The trader earns the option premium upfront, which serves as income. However, the upside is capped, since if BTC rallies above the strike, the asset may be “called” away at that level. This strategy isn’t ideal for someone who isn’t willing to sell their BTC, unless they’re setting very high strike prices, though doing so will result in less yield earned from the premium.
This investment generates weekly income but limits your exposure to Bitcoin.
Borrowing/lending and derivatives are key pillars of the BTC yield equation
Borrowing against BTC for stablecoins has clear user demand. Also, structured products that harness trading activity on BTC are gaining traction.
I’m closely watching these strategies as sources of BTC yield.
Thanks for reading — please feel free to reach out on X with any comments.