With the launch of Lombard and Babylon, Bitcoin staking is gaining momentum as a key asset in the restaking industry. Following the recent partnership with ether.fi, Chaos Labs has taken the initiative to identify and monitor potential risks associated with Bitcoin staking. This analysis reflects our current understanding of these risks based on publicly available information as of 2024/09/11. Since staking, withdrawals, and slashing have yet to be activated on Babylon, parts of our analysis remain theoretical.
Introduction
Lombard seeks to unlock Bitcoin’s value within the DeFi ecosystem by leveraging Bitcoin staking. It utilizes the Babylon protocol, which allows Bitcoin holders to stake their BTC directly on PoS-blockchains. Lombard introduces LBTC, a liquid staked token that represents BTC staked via Babylon. LBTC is designed to generate yield from both Babylon’s native staking rewards and Lombard Lux, the protocol’s reward system for early adopters. Currently only live on Ethereum mainnet, LBTC is intended for use across multiple blockchains, where it can be integrated into various DeFi applications.
Technical Analysis
Depositing and Staking
When depositing on Lombard, users send BTC to a unique SegWit address. Lombard generates a distinct SegWit Bitcoin deposit address for each user, utilizing CubeSigner—a tool that securely stores all keys in dedicated hardware and enables the creation of custom policies around keys usage. Lombard uses it to enforces strict access controls, allowing transactions exclusively with Babylon and requiring multi-party approval (MPA).
Lombard’s architecture centers around the Security Consortium, a distributed network of nodes, each managed by a different organization. When a user deposits BTC, every consortium member independently verifies the transaction on the Bitcoin network.
Once validated, the consortium collectively signs a notarized proof. The user then submits this signed proof to the LBTC smart contract on the Ethereum mainnet, triggering the minting of an equivalent amount of LBTC.
Source: Lombard Documentation
Simultaneously, the notarized proof triggers the staking of the deposited BTC with Babylon. A special transaction is created, detailing the BTC amount, the Babylon Staking Contract address, a timelock that defines the duration of the BTC stake on Babylon and selects finality provider, which are equivalent to validators of PoS networks. The consortium then signs this transaction and the BTC gets deposits onto Babylon. For BTC deposits, Babylon uses Bitcoin’s native scripting capabilities to create timelocked UTXO contracts. Once the transaction is received in the contract, the user’s deposited stake will be allocated in form of voting power to the corresponding finality provider.
The Security Consortium also transfers an Extractable One-Time Signature (EOTS) to the finality provider, which serves as proof of ownership of the deposited BTC. When the finality provider participates in finality votes on a PoS network, they use the EOTS for the signatures, demonstrating control over the staked BTC delegated to them by Lombard, without having access to the actual private keys.
Source: Babylon Documentation
Slashing
If the finality provider violates consensus rules by double-signing, the EOTS cryptographic mechanism exposes the private key of the contract, where the provider’s delegated BTC is locked. This allows anyone on the network to use the key to initiate a slashing transaction on the Bitcoin blockchain. The transaction burns a portion of the deposited BTC by transferring it to a specific address designated by the Babylon protocol for slashed funds.
Unstaking and Withdrawals
A user on Lombard initiates the unstaking process by burning LBTC tokens, triggering a request to the Security Consortium to unstake the corresponding BTC from Babylon. After the 7-day withdrawal period set by the Babylon protocol, a bridge contract on Ethereum facilitates the BTC withdrawal using another mechanism called the Bascule Drawbridge. The Bascule Drawbridge verifies the request by checking its internal depositHistory mapping for a corresponding deposit record, ensuring the withdrawal matches a previously validated deposit.
Economic Analysis
Lombard is currently in public beta, which makes LBTC available to the public whilst restricting deposits to whitelisted users. At time of writing, there have been 4,612 LBTC minted, resulting in a TVL of approx. $264M, since its launch on August 21st.
Both the Curve and Uniswap pools have increased their liquidity, with Curve holding $1.4 million (24 BTC) and Uniswap holding $16 million (393 BTC).
Babylon has implemented a cap on deposits during its Phase 1 launch. After Babylon’s initial cap of 1,000 BTC was reached, Lombard continued accepting BTC deposits and minting LBTC. Deposits that couldn’t be transfered to Babylon are being held in users’ SegWit addresses, which are managed via CubeSigner, until Babylon raised its deposit cap.
Risk Considerations
- The technical implementation for deposits, withdrawals, and staking on Babylon, utilizing CubeSigner, multi-party approval, and EOTS, appears to provide a reasonably secure framework for BTC staking. The independent verification process via the Bascule Drawbridge adds an extra layer of protection and could help mitigate potential bridge hacks in the future.
- The protocol’s architecture places significant dependency on the Security Consortium, which plays a critical role in staking, unstaking, and delegating to finality providers. There is currently limited transparency around the Consortium’s members and decision-making processes, including how new members are selected, finality providers are chosen, and timelock parameters are set. Additionally, there is little information on incentives or penalties for Consortium members, making it difficult to assess the mitigation of potential collusion. This introduces a trust assumption that the Security Consortium does not act maliciously.
- Key elements of the Lombard user experience are influenced by parameter decisions made by Babylon, making the protocol dependent on Babylon’s governance. This includes decisions regarding the withdrawal period, which can affect Lombard users by delaying access to their funds, potentially resulting in opportunity costs and exposure to price fluctuations during the waiting period.
- Similar to other LRTs, LBTC faces potential price volatility and depegging risks. On the liquidity front, both Curve and Uniswap have shown positive signs with increasing LBTC liquidity, signaling growing adoption. However, the current trading pair is limited to WBTC, raising concerns about the need for more diversified exit liquidity options in the future, especially given the medium-term uncertainties surrounding WBTC due to Bitgo’s ongoing corporate restructuring.
- Staking on Babylon will not be available until the next phase, with no confirmed timeline. Currently, LBTC provides no income from restaking. While Babylon is distributing points during this interim period, these are awarded to depositors through the Lombard Finance protocol, not LBTC holders. Instead, LBTC holders receive Lombard Lux rewards. Any changes to the point reward system could potentially hinder LBTC adoption.
Conclusion
LBTC is a restaking innovation by unlocking BTC as a staking asset. Chaos Labs generally views the token and underlying Lombard and Babylon protocols as economically safe. At the same time we acknowledge certain trust assumptions around the security consortium and WBTC as the only trading pair.
Disclaimer
This analysis is based on a best-effort review of publicly available information as of 09/11/2024. Given the rapidly evolving nature of the sector, the relevance and accuracy of the analysis may change over time. We are not responsible or liable for any inaccuracies, omissions, or outdated information that may result from changes in the industry or new developments. Readers are advised to conduct their own research and seek professional advice as necessary.