BTCFi Reality Check: Why Bitcoin L2s Lost 74% of TVL While Babylon Captured Nearly Everything
Here's an uncomfortable truth about Bitcoin DeFi: 77% of BTC holders have never touched it. And the 23% who have are increasingly concentrated in a single protocol. While the BTCFi narrative exploded in 2024—with TVL surging 2,700% year-over-year to over $7 billion—the 2025 reality has been far more sobering. Bitcoin L2 TVL has collapsed by 74%, fake statistics have eroded trust, and one protocol now commands 78% of all Bitcoin locked in DeFi. This is the story of BTCFi's reckoning, and what it means for the ecosystem's future.
The Great Contraction: 74% TVL Decline on Bitcoin L2s
The numbers paint a stark picture. Bitcoin L2 TVL has shrunk by over 74% in 2025, while broader BTCFi TVL declined 10% from 101,721 BTC to 91,332 BTC—representing just 0.46% of all Bitcoin in circulation.
To put that in perspective: only about 0.8% of BTC by value is currently utilized in DeFi. The sector that was supposed to unlock Bitcoin's $2 trillion market cap for productive use has barely scratched the surface.
The Rootstock Example
Rootstock, the oldest and one of the most established Bitcoin sidechains, saw its Q1 2025 TVL drop 7.2% in BTC terms and 20% in USD terms to $179.9 million. While TVL briefly peaked at $244.6 million during January's Bitcoin price rally, it trended steadily downward from March.
This pattern repeated across the ecosystem. Once incentive programs ended, liquidity fled. The comparison to Ethereum's Blast rollup is apt—Blast's TVL dropped threefold in three months once its rewards dried up.
Why L2s Struggled
The fundamental problem: launching the same DeFi primitives seen on EVM-based L2s onto a Bitcoin chain isn't enough to attract liquidity or developers. Bitcoin's UTXO model adds complexity that undermines user trust. Transaction throughput remains abysmal—Merlin Chain processes around 1 TPS, while Rootstock manages less than 1 TPS (5-15 transactions per minute).
Compare that to Solana's thousands of TPS or even Ethereum L2s averaging 50-100 TPS, and the user experience gap becomes obvious.
Babylon's Total Dominance: 78% Market Share
Against this backdrop of L2 decline, one protocol emerged as the clear winner: Babylon.
Approximately 78% of Bitcoin's total DeFi TVL is now held in Babylon, making it the dominant force in BTCFi. The protocol has attracted over 57,000 BTC ($4.6 billion) since its August 2024 launch, dwarfing every competitor combined.
Why Babylon Won
Babylon's architecture solves problems that plagued other BTCFi approaches:
- No bridges or wrappers: Bitcoin can be staked natively without trusting third-party custodians or wrapped token mechanisms
- No custody transfer: Users maintain control of their BTC while providing cryptoeconomic security to proof-of-stake systems
- Real yield generation: Staking rewards flow from securing external chains, not from inflationary token emissions
- Institutional integration: Kraken announced Babylon as its Bitcoin staking solution in August 2025, bringing native BTC staking to mainstream exchange users
The Babylon Genesis mainnet became the world's first Layer 1 blockchain secured by Bitcoin, moving native staking from theory to production. For the first time, Bitcoin could provide economic security to PoS systems through a trust-minimized mechanism.
Lombard's Distant Second
Behind Babylon, Lombard holds approximately $1 billion in TVL—making it the only other BTCFi protocol at scale. The gap between first and second place tells the story: Babylon isn't just winning, it's capturing nearly the entire addressable market.
The TVL Scandal: Solv Protocol and the Trust Crisis
If Babylon represents BTCFi's success story, the Solv Protocol controversy represents its credibility crisis.
The Allegations
On January 3, 2025, Nubit co-founder Hanzhi Liu publicly accused Solv Protocol of TVL manipulation. The core allegation: Solv's SolvBTC wrapped Bitcoin asset relied on pre-signed transactions that allowed the same Bitcoin to be counted multiple times across different platforms.
Liu claimed one BTC in SolvBTC could be reported as three BTC by leveraging duplication across various protocols. He issued a "scam warning," urged users to withdraw, and compared Solv's transparency to FTX.
Solv's Defense
Solv Protocol denied all accusations, calling them "unfounded" and attributing TVL fluctuations to routine redemption processes. Co-founder Ryan Chow accused competitors of orchestrating a deliberate campaign to damage Solv's reputation.
According to DeFiLlama, Solv manages approximately $2.5 billion in TVL—making the stakes of this dispute significant.
The Broader Problem
The Solv controversy isn't isolated. In response, leading BTCFi projects—including Nubit, Nebra, Bitcoin Layers, and Alpen Labs—released a "Proof of TVL" report on January 5, 2025. The report addressed systemic problems:
- False statistics and double counting
- Fake locking mechanisms that inflate metrics
- Bitcoin's UTXO model making TVL verification complex
- Lack of standardized transparency mechanisms
The report proposed an open-source TVL verification tool and called for higher asset transparency standards. But the damage to trust was already done—surveys show 77% of BTC holders have never used BTCFi, and UX/trust gaps are primary reasons.
The L2 Landscape: Who's Still Standing
Despite the overall decline, several Bitcoin L2 projects continue building. Here's how they compare:
Stacks
- Launch: 2018 (conceptualized 2013)
- Mechanism: Proof of Transfer (PoX)—miners spend BTC to mint Stacks blocks
- Status: Hit 5,000 sBTC bridge cap in under 2.5 hours, demonstrating demand
- Limitation: Requires learning Clarity language, limiting developer adoption
Rootstock (RSK)
- Launch: 2018
- Mechanism: Merge mining with Bitcoin (secured by 60% of BTC hash power)
- Status: 120+ Web3 apps, EVM compatible, 300+ TPS theoretical
- Limitation: Tethered to Bitcoin block times, lacks modern rollup innovations
Merlin Chain
- Launch: February 2024
- TVL: Surpassed $1.7 billion (August 2025)
- Mechanism: ZK-rollups with EVM compatibility
- Advantage: Supports BRC-20 tokens and Ordinals in DeFi
- Limitation: ~1 TPS actual throughput
Core
- Evolution: Transitioning from Bitcoin staking to full-stack BTCFi ecosystem
- 2026 Focus: Institutional adoption, revenue models, LSTs
- Integration: London Stock Exchange-listed ETPs targeting corporate treasuries
No single L2 has achieved dominant market share. TVL remains distributed relatively evenly across the set—but "even" means "small" when the total pie has contracted 74%.
The Institutional Angle: A $100 Billion Opportunity
Despite current challenges, the BTCFi thesis remains compelling. Here's the math:
- Bitcoin market cap: ~$2 trillion
- Current BTCFi utilization: ~0.8%
- Target utilization: 5%
- Implied BTCFi market: $100 billion
Galaxy Digital Research projects over $47 billion of BTC could be bridged into Bitcoin L2s by 2030, with 2.3% of circulating supply participating in BTCFi ecosystems.
Institutional Interest Is Real
A 2025 survey found 43% of institutions are exploring Bitcoin yield opportunities including lending and staking. Over 172 publicly traded companies held Bitcoin as of Q3 2025—up 40% quarter-over-quarter—collectively holding approximately 1 million BTC.
The problem isn't demand. Institutions want Bitcoin yield. The problem is infrastructure—security models that match institutional risk tolerance, regulatory clarity, and user experiences that don't require PhD-level blockchain knowledge.
Grayscale's 2026 Outlook
Grayscale expects Congress to pass bipartisan crypto market structure legislation in 2026, cementing blockchain-based finance in U.S. capital markets. Combined with the GENIUS Act (stablecoins) passed in 2025, regulatory tailwinds may finally align with institutional appetite.
2026 Outlook: Consolidation and Maturation
The BTCFi sector enters 2026 facing simultaneous headwinds and tailwinds.
Headwinds
- Security risks: Nascent protocols mean smart contract vulnerabilities and potential exploits
- Regulatory uncertainty: Evolving frameworks may impose compliance requirements deterring participation
- Trust deficit: TVL scandals have eroded confidence in reported metrics
- UX gaps: 77% of BTC holders haven't engaged with BTCFi
Tailwinds
- Babylon's continued dominance: A clear market leader provides stability and standards
- Institutional demand: 43% of institutions exploring BTC yield products
- Regulatory clarity: Expected 2026 legislation from Congress
- BitVM development: Babylon Labs continues R&D on trustless cross-chain BTC via BitVM, with first applications expected Q1 2026
What to Watch
- Babylon's BitVM implementation: Native Bitcoin liquidity layer enabling trustless cross-chain use
- TVL verification standards: Whether "Proof of TVL" initiatives gain adoption
- L2 consolidation: Which projects survive once incentives fully expire
- Institutional products: Core's LSE-listed ETPs and similar offerings
Separating Signal from Noise
BTCFi's 2025 reality check delivers a clear verdict: the sector is real but immature. Babylon has proven that native Bitcoin staking can work at scale—$4.95 billion in TVL with no bridges, wrappers, or custody transfer is a genuine innovation.
But the broader L2 ecosystem has not delivered. 74% TVL decline, fake statistics, 1 TPS throughput, and developer friction have prevented Bitcoin DeFi from capturing even 1% of BTC supply.
The opportunity remains enormous. If 5% of Bitcoin's market cap eventually flows into DeFi, that's a $100 billion market. But getting there requires solving trust (no more TVL manipulation), UX (better than 1 TPS), and security (institutional-grade custody) simultaneously.
Babylon has captured the restaking narrative. The question for 2026 is whether anyone else can build the lending, borrowing, and trading infrastructure that transforms Bitcoin from a static store of value into productive collateral. The race is far from over—but the field has narrowed dramatically.
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