So What would be the correct setup for the scenario I mentioned above? I want to make sure everything is being backed-up.
It really depends on your usecase and which risks you are willing to take. For professional setups it's recommended to setup a dedicated local PBS onsite and offsite with enterprise SSDs in a RAID mirror (ZFS is great for it, but hardware RAID would work too of course). The benefit is that even if the actual PVE host gets broken you still have your VMS together with PBS on a system which doesn't need ProxmoxVE to run.
For a homelab this might be a little bit overkill though and depending of what you want to achieve it might still be a good setup to setup ProxmoxVE as VM. I remember a discussion in the German forum, where some professionals mentioned their setup for their customers offsite backups. They basically rent a dedicated server from some hoster with enterprise disks in them. Then they first install ProxmoxVE on it and afterwards PBS as a VM on it. The benefit is, that they now have an offsite PBS which sync the PBS backups from the customers main locations PBS to the dedicated server.
So their customers have now three copies of their VMs: One in production, one onsite and another one offsite in multiple snapshots so even if one copy is lost you can still go back to an older one. This is especially important in case of an Ransomware attach where the ransomware or hacker might have managed to take over the complete local infrastructure (which then needs to be remade completly) but not the offsite one which then yould be used as starting point for setting up everything again. The PBS manual has a chapter on ransomware protection with backups:
https://pbs.proxmox.com/docs/storage.html#ransomware-protection-recovery
The problem in running PBS as vm however is what do you do when the ProxmoxVE has some problems Then you first need to come back to a running PVE, then need to resetup PBS before starting the restore. On the other hand a PBS vm can easily backed up itself with ProxmoxVEs native vzdump function. So: Pick your poison
I personally do something mixed for my homelab: I have three mini-pcs. Two of them are my lab cluster. The third one is a standalone-install of ProxmoxVE (called naspve) containing a NAS VM and a PBS VM (which also act as a qdevice for the actual lab cluster). The VMs of my cluster are backed up at least daily to the PBS VM on naspve and then synced daily to a cheap netcup vserver (around 10 Euro per month) with a running PBS for offsite backup. Once a week the native vzdump function creates additional backups of the cluster vms and of the NAS and PBS vm. These would even work if I lost everything stored in the local and offsite PBS. The vzdumps are backuped on a cloud storage with restic. restic also takes care of my actual data (stuff stored on my notebook and in the NAS) since the cloud storage has more space than the vserver.
For my needs this is a good setup but it should also be noted that up to now I didn't had the time to do a complete manual restore test so take my words with a grain of salt.
Yyour usecase might be quite different though. Just one example: Since PBS now supports external datastores it might be more practical or cheaper for you to just backup everything in a local PBS (plus a vzdump backup of the PBS if it's in a VM) and sync it to an external USB drive once a week. If you have more than one external drive and remember to store one of them offsite (e.g. your office, a family member or friends place) and swap them on a regular schedule this might be a good solution for you which might be easier or cheaper to achieve. Again: Pick your poison