# Babylon staking: Backing PoS security with Bitcoin market cap

Within days of Babylon mainnet cap 2, 1.6 billion dollars [1] worth of BTC are staked. While Babylon promises sustainable yields from securing other chains, the rapid influx of Bitcoin maybe pushing the system yield engine to its limits. Are we witnessing the dawn of Bitcoin's Babylon DeFi summer, or the buildup to its most spectacular yield crash?

# I. Situation
## I. 1. DeFi summer promise on Bitcoin
For a very long time, people have been trying to recreate the DeFi success of Ethereum and Solana on Bitcoin. Bitcoin's huge market cap promises massive TVL potential for native DeFi protocols, potentially greater than all other ecosystems combined. The only remaining challenge is to overcome Bitcoin's limited script expressiveness and extremely slow block time. This is the holy grail that many are pursuing - a DeFi summer on Bitcoin fueled by its massive market cap.

## I. 2. Sustainable yields promise through Bitcoin staking
Babylon introduces a novel Proof-of-Stake staking engine natively on Bitcoin. This technology enables Bitcoin holders to stake and secure other blockchain networks remotely, creating a new revenue stream. Other PoS chains will always inflate their token supply to reward validators. While the underlying technology is complex, the value proposition is straightforward: Bitcoin depositors can earn sustainable yields from other chains' staking inflation mechanisms.

## I. 3. LST overdrives Bitcoin Staking
The TVL locked in staking would normally be dead TVL, unable to be used for any other DeFi use cases. Liquid staking (LST) changes this by offering a token as ownership representative of locked Bitcoin. Stakers can then use that LST token to participate in any other DeFi protocols. But, the real magic lies in the LST loop that can multiply the initial TVL amount by 5x.

Let's look at an example of how LST loop can be:

Chad initially stakes 1 BTC into Babylon through an LST protocol for 1 LST.BTC
He swaps that 1 LST.BTC for 1 BTC, then stakes that new BTC for another 1 LST.BTC
Chad has just done a loop, with 2 BTC staked
With 4 more loops like this, Chad's total staked amount of BTC is now 5 BTC
He now receives the rewards of 5 staked BTC, with just 1 initial BTC
To regain the staked BTC, he bets that he can buy back 4 more LST.BTC at possibly cheaper price in the future

As of November 2024, major LST protocols attracted nearly $3 billion [2] worth of BTC from depositors in centralized custody wallets. Seven leading LST protocols account for 79% of the $1.6 billion worth of BTC staked in Babylon.

# II. Complications
## II. 1. Massive deposits demand massive yields
On one end, Babylon needs to attract a lot of BTC from stakers to fuel the security mechanism. They've successfully attracted massive volume with the help of LST protocols. On the other end, Babylon needs L2s to pay for the Bitcoin PoW security to maintain such volume of TVL. With the expected annual yield rate of around 3-5%, Babylon would need to reward around 48-80 million in other chain native tokens.

## II. 2. LSTs' Unsustainable Yield Race
LSTs are directly responsible for attracting and paying yields to 76% of BTC on Babylon. If Babylon cannot return enough yields, then these protocols must find other sources of yields to maintain the TVL. They have been aggressively integrating the LST.BTC into many DeFi protocols on Solana, Ethereum, Berachain, and others.

Given the urgency of securing limited yield sources, it's understandable that they have to go to market quickly. The quickest widely adopted LST.BTC will win the race. Many checks and corners have to be cut, with concerns delayed for future consideration.

# III. Key Questions
## III.1. How would Babylon sustain yields to BTC depositors?
With recent raised amount of 70 million from Paradigm, Babylon may be able to maximally cover the yields for 2 years. Until that date, Babylon needs to develop a real market for Bitcoin staking, with actual sustainable yields. There could be many strategies, from leveraging the DeFi magic of LSTs or actually convincing other chains to adopt Babylon as a security measure. Currently, there is a point program instead of yields to incentivize people to participate.

We are still in the early days of the Babylon era. If Bitcoin staking is proven to be a viable DeFi model on Bitcoin, more stakers would flock to Babylon. As a result, we may observe a new Babylon DeFi summer. There is truly a lot of prospects yet to be seen!

## III. 2. What risks LSTs are facing?
The race for yield sources has created a concerning pattern among LST protocols, characterized by two major risk factors:

Rushed Market Entry and Integration: LST protocols are rapidly integrating with any available yield source on multiple chains. Thus, complex cross-chain integrations maybe implemented without enough security audits or infrastructure.
Centralization and Custody Risks: Large amounts of BTC are held in trusted centralized custody wallets with no clear contingency plans if compromised.

A major crash from one of the LSTs could delay the Babylon DeFi summer. This is a scenario that we don't want to see. So, we are actively analyzing these risk factors to provide solutions

# IV. References
https://btcstaking.babylonlabs.io/
https://www.intotheblock.com/