Crypto 101 · Research papers
Using DeFi with Proof-of-Work and Proof-of-Stake Assets
Abstract
Decentralised finance runs on proof-of-stake smart-contract networks, but many scarce assets are issued on proof-of-work networks. This paper describes the practical path between them: keep the asset native, wrap it to a proof-of-stake network, use it in trading, lending or liquidity provision, and return it home. We explain each activity, quantify impermanent loss for a constant-product pool, and list the risks each step adds.
Keywords: DeFi, liquidity pool, impermanent loss, lending, staking, bridge, proof of work, proof of stake
1. Two kinds of network, three moves
The thesis of this series is that proof-of-work networks are strong at issuing scarce assets and proof-of-stake networks are strong as financial rails [1, 2]. Using both gives three moves.
1. Hold natively. Keep the asset on its own chain with keys you control. This is the simplest, and it is where the issuance rules apply. 2. Wrap to reach markets. Deposit the asset with a bridge and receive a representation on a proof-of-stake network, subject to the conservation principle [3, 4]. 3. Use it, then return. Trade, provide liquidity or lend, then burn the wrapped token to release the native asset when you want to go home.
2. What you can do on the proof-of-stake side
Table 1. Activities and where they run.
| Activity | What it is | Who pays you |
|---|---|---|
| Swap | Exchange one token for another through an automated market maker or aggregator | Nobody; you pay a fee and price impact |
| Provide liquidity | Deposit two tokens in a pool that others trade against | Traders, through fees [5] |
| Lend | Deposit an asset for borrowers to use | Borrowers, through interest |
| Stake or delegate | Lock the network's native token to help secure it | The network, through issuance and fees [6] |
| Mine (proof of work) | Provide hash power on a proof-of-work chain | The network, through subsidy and fees [7] |
3. Impermanent loss
A constant-product pool rebalances as prices move, so a liquidity provider ends up holding more of the asset that fell and less of the one that rose [5]. If one asset's price changes by a factor r relative to the other, the pool position is worth a fraction of the hold-only value:
value ratio = 2 * sqrt(r) / (1 + r)
For r = 2 the ratio is 2 x 1.4142 / 3 = 0.9428, so the provider is about 5.7% behind simply holding, before fees. Fees are the compensation; whether they exceed the loss depends on volume and volatility.
4. Risks added at each step
- Bridge risk on step 2: the backing may not be sufficient or accessible; check proof of reserves.
- Smart-contract risk on step 3: bugs or exploits in a pool or lending market can lose funds.
- Liquidity risk: a wrapped token may trade away from its native asset in a thin market.
- Liquidation risk in lending: if borrowed positions fall below thresholds, collateral can be sold.
- Yield risk: a high advertised return may be funded by token emissions, not revenue; see the next paper.
5. Proof of stake as rails, proof of work as asset
This is the practical meaning of the thesis. A miner who holds proof-of-work coins and wants to earn from liquidity does not need the coin's own chain to support it; the wrapped form on a proof-of-stake network does the job. Conversely, a holder who uses Solana daily can keep a portion of their savings as a native proof-of-work asset whose supply does not respond to anyone's decision.
References
- Buterin, V. (2013). Ethereum Whitepaper: A Next-Generation Smart Contract and Decentralized Application Platform. Whitepaper (maintained at ethereum.org). https://ethereum.org/en/whitepaper/
- Yakovenko, A. (2017). Solana: A new architecture for a high performance blockchain. Whitepaper introducing Proof of History. https://solana.com/solana-whitepaper.pdf
- Board of Governors of the Federal Reserve System (2023). Tokenization: Overview and Financial Stability Implications. Finance and Economics Discussion Series 2023-060. https://www.federalreserve.gov/econres/feds/files/2023060pap.pdf
- Scrypt Bridge (2026). Proof of Reserves. Live page comparing native coins held in reserve with wrapped tokens outstanding. https://bridge.scryptwallet.io/proof-of-reserves
- Adams, H., Zinsmeister, N., Salem, M., Keefer, R., & Robinson, D. (2020). Uniswap v2 Core. Whitepaper: constant-product automated market maker with fees paid to liquidity providers. https://uniswap.org/whitepaper-v2.pdf
- ethereum.org (2022). Proof-of-stake (PoS). Ethereum developer documentation for the proof-of-stake consensus mechanism. https://ethereum.org/en/developers/docs/consensus-mechanisms/pos/
- Nakamoto, S. (2008). Bitcoin: A Peer-to-Peer Electronic Cash System. Whitepaper. https://bitcoin.org/bitcoin.pdf
Common questions
Can I use Bitcoin or Litecoin in DeFi directly?
Not on their base layers, which have limited programmability. The usual route is to use a backed, wrapped representation on a smart-contract network, and to check how the backing is verified.
What is impermanent loss?
The difference between the value of tokens deposited in a constant-product pool and the value of simply holding them, which arises when their relative price changes. For a doubling of one asset's relative price it is about 5.7%.
General education, not financial, tax or legal advice. Figures are schematic. Protocol parameters are cited to primary sources and can change; verify against the linked source before relying on them.