Never in the history of the universe has so much financial opportunity been available to so many. Bitcoin has grown remarkably as a store of value for the people by the people, giving citizens around the world a piece of their economic freedom. At the same time, Satoshi’s mission to make the financial system work for everyone has found expression in the exciting decentralized finance, or DeFi, space.
DeFi has grown from a mere experiment into a multi-billion dollar sector that consists of applications for savings, trading, lending, options, insurance, and other financial functions. This new class of financial application has generated attractive yields while eliminating the need to trust intermediaries. While the central hub of DeFi is on Ethereum, Bitcoin holders also have the opportunity to access DeFi through wrapped Bitcoin tokens. A wrapped Bitcoin token is a token that mirrors the price of Bitcoin and is directly exchangeable for the real thing. At the same time, wrapped Bitcoin tokens are compatible with Ethereum and the DeFi applications built on top of it.
DeFi isn’t very welcoming for newcomers due to their technical nature. That’s why we’ve put together this step-by-step guide to show you how to transform your Bitcoin and Ether into yield-generating assets through DeFi. Specifically, we’ll be wrapping Bitcoin and then depositing wrapped Bitcoin and Ether into Uniswap, one of the leading DeFi platforms. By the end of the guide, you’ll be much more familiar with the world of DeFi, and you’ll have the tools to navigate its technicalities. This tutorial assumes that you have some Bitcoin and Ether on hand with which to experiment. If you don’t have any, rush over to Coinmama to get some ETH and BTC now.
But before we dive straight into the nitty-gritty of earning yield with Bitcoin and Ether, we need to get some crucial concepts out of the way first. We’ll start by explaining what it means to become a Uniswap liquidity provider and move on to wrapping your Bitcoin.
If you’re already familiar with the basics, feel free to skip the intro and get straight down to business.
What is a Uniswap liquidity provider?
Uniswap is a cryptocurrency exchange. You’re probably familiar with a few already. However, Uniswap works quite differently to most of the exchanges you’re used to.
An ordinary exchange brings together buyers and sellers to trade with one another. Traders use an orderbook to record the prices at which they wish to buy or sell a token. Once the orderbook matches a buyer and a seller, the trade executes, and the coins change hands.
Uniswap does not use an orderbook to match buyers and sellers. Instead, it relies on a unique system known as an automated market maker. An AMM is essentially a smart vault that holds two assets, for example, Bitcoin and Ether, and allows traders to trade with the AMM.
For example, say Todd has Ether and wishes to swap it for Bitcoin.
- On a regular exchange, he would place a sell order on his Ether, and the exchange would find someone who wants to buy his Ether at his specified price.
- On Uniswap, Todd would send Ether to the ETH-BTC automated market maker instead of finding a counterparty to buy his Ether. The AMM then sends Todd an amount of Bitcoin according to a dynamic exchange rate.
What’s so incredible about Uniswap, you may ask? To answer this question, we must take off our trader’s hat and put on a completely different hat – that of a market maker. In almost every market, market makers play a crucial role in providing liquidity, and for which they get compensated in various ways, including through trading fees. Traditionally, the part of market maker was reserved for high-net worth individuals and big institutions. Even today, traditional exchanges exclude ordinary folk from the opportunities of making markets when it comes to stocks, bonds, and other conventional assets.
Uniswap’s game-changing innovation lies in allowing anyone to become a market maker and earn fees. By locking up tokens in an AMM, Uniswap liquidity providers create the asset pool with which traders can swap tokens.
Wrapped Bitcoin vs. Bitcoin
Remember we said earlier that this tutorial would show you how to earn with Bitcoin and Ether through DeFi? Well, it isn’t exactly Bitcoin that we’ll be using.
Rather, we’ll leverage a derivative of Bitcoin for reasons that will be clear in a second.
You see, Bitcoin itself is not compatible with Uniswap, or any other DeFi project. Bitcoin runs on a different network to Uniswap, which runs on Ethereum. Think about it as trying to download an Android app onto your iPhone – it just won’t work. In the case of the Android app, a workaround would be to create a version of the app that is specifically designed for iPhone.
Wrapped tokens accomplish something similar by allowing users to bridge tokens in between blockchains, effectively creating a version of Token A that is compatible outside of its home blockchain. In our case, we want to bridge our Bitcoin over to Ethereum to put it to use in a Uniswap pool. To achieve this, we’ll be using REN, an application that lets us wrap Bitcoin and make it compatible with the Ethereum network.
We’ll start by locking our Bitcoin in the REN vault and minting an equivalent amount of renBTC on the Ethereum blockchain. renBTC is an Ethereum-compatible token (ERC20 token) that mirrors the price of Bitcoin. If we wish to get back our Bitcoin, we can burn the renBTC in our possession, and the RenVM will send us Bitcoin equal to the amount we burnt.
Step-by-Step Guide to Becoming a Uniswap Liquidity Provider using Ether and Wrapped Bitcoin
It’s time to get straight to it and put our assets into a yield-bearing pool on Uniswap. The first step for those who don’t have any Bitcoin or Ethereum is to get some, fast. You can do so by heading over to Coinmama and creating your account if you don’t have one already.
Before we start, let’s talk about gas quickly. Gas is the fee we need to pay to take any action on Ethereum. The more complex the action, the more gas we pay. Even if you’ve paid gas to send Ether before, you might be surprised by the high cost of gas involved with depositing into DeFi. While many talented teams are working to solve for the friction caused by gas, this is just the way it is, for now.
Step 1: Download Metamask
Metamask is a wallet that connects you to the decentralized internet. Available as both a browser extension and a mobile app, Metamask is the gateway to DeFi we’ll be using in this demo. Simply head over to the Metamask website and download the correct version. Don’t forget to write down your seed phrase and store it someplace safe! Wallet security comes first.
Step 2: Get Wrapped Bitcoin
As we mentioned before, Bitcoin is incompatible with Uniswap so we’ll have to wrap our Bitcoin before we can deposit it into the pool. Head over to the Ren bridge to make it happen. You’ll be asked to connect your Metamask wallet, which you should do. Make sure that you are ‘Minting’ (sending ‘Bitcoin’ to the destination ‘Ethereum’) and click Next. Once you’ve done that you’ll be taken to a screen that will display a Bitcoin address to which you must send funds.
The REN bridge waits for 6 block confirmation on the Bitcoin side before you can issue renBTC, the wrapped Bitcoin token on the Ethereum side. This generally takes around an hour. So take a break, have a coffee, go for a stroll and come back once the transaction has been confirmed.
At that point, you’ll be prompted to mint renBTC which will send tokens to the Metamask address you connected before.
Step 3: Deposit Ether and Wrapped Bitcoin (renBTC) into a Uniswap Pool
Finally we have some ETH and some renBTC in hand and are ready to deposit them into the Uniswap pool. Go to the Uniswap app and click on the ‘Pool’ option in the main toolbar. Then, click on ‘Add Liquidity.’ You’ll notice that the first token is automatically set to ETH. Below that, click ‘Select Token’ and search for renBTC. Found it? Great. Now you’re screen should look something like this:
Under the ‘Input’ field, choose how many tokens you wish to deposit into the pool. Bear in mind that Uniswap requires you add equal amounts of liquidity to both assets in the pool, so if you deposit $1,000 worth of ETH you’ll need to deposit exactly $1,000 worth of renBTC.
DeFi Can Be Dangerous. Always Do Your Own Research
Did you notice all those disclaimers scattered throughout Uniswap and REN warning you about the experimental nature of these platforms? DeFi is merely a couple of years old, and like any new technology, is still experiencing some growing pains. From smart contract failures, to dishonest entrepreneurs draining funds of their own applications (known as a ‘rug pull’), to impermanent loss, DeFi contains many different risks that should be taken into account.
The future of DeFi looks bright, and it’s exciting to think that we have an opportunity to play with the financial platforms of the future. But don’t mistake an experimental financial platform for a safe investment.