DeFi: Babylon Labs offers Aave to accept native bitcoin as collateral, without an intermediary

In DeFi, access to credit often remains linked to tokenized or custodial assets. Babylon Labs wants to change this logic with a proposal submitted to Aave governance. The project aims to allow Bitcoin holders to borrow on version V4, without a bridge, without a classic wrapper and without a centralized custodian. This initiative is still moving forward in stages, with an initial community sentiment vote.

Native Bitcoin: a guarantee designed to reduce intermediaries

Babylon Labs has filed a “Temperature Check” with the Aave DAO in order to test the reception of its architecture. The heart of the proposal is Trustless Bitcoin Vaults, vaults designed to lock BTC directly on their original chain. The depositor therefore retains native exposure, while creating a corresponding record on Ethereum.

The described mechanism uses Taproot scripts and UTXO outputs. Once the funds are blocked, adapter contracts represent the vault in the form of vaultBTC. This token does not circulate freely: it remains limited to the Hub V4, the Core Lending Spoke and the integration contract. This restriction seeks to prevent a representation asset from becoming a transferable instrument outside the intended framework.

This approach gives Bitcoin a more direct role in decentralized lending. It also avoids models where the user must go through a bridge, a consortium of signatories or a wrapped asset before borrowing. In this scheme, Bitcoin remains on its chain, while credit is processed in the DeFi environment.

Aave V4 at the center of a Hub-and-Spoke architecture

There proposal plans two new Spokes on Ethereum. The Babylon Core Lending Spoke would allow borrowing supported assets, such as stablecoins or wrapped BTC, with native collateral. The BTC Vault Swap Spoke would then process liquidations, converting seized collateral into WBTC for unauthorized liquidators.

Aave V4 currently only accepts ERC-20 tokens as collateral. For this reason, vaultBTC serves as a technical representation between the original chain and the lending environment. The system maintains a direct correspondence between each vault and its restricted token, which governs operational functioning.

The role of governance remains central. The Aave V4 Hub, bid caps, borrowing caps, risk settings and general supervision remain under the control of the Aave DAO. Babylon Labs also says that details on oracles, trust assumptions and full risk management will come in a later ARFC stage.

Liquidations, WBTC and Next Governance Steps

The proposal also describes a specific circuit for liquidations. When a Bitcoin-backed position is liquidated, an unauthorized actor exchanges the seized vault for WBTC at a small premium. Then, authorized arbitrageurs purchase these escrow vaults, repay the debt, and recover the native funds on the original chain.

This arrangement separates the moment of liquidation from the final redemption of BTC. This allows liquidators to settle faster, while the Bitcoin process follows its own timeline. Babylon Labs also presents this model as a way to create a new borrowing demand for the WBTC already present on the platform.

The project is subject to audits by Coinspect, Sherlock, Zellic, ABDK and ZK Security. A formal verification is also carried out by Runtime Verification. The first reactions cited in the governance thread seem favorable, particularly from technical contributors and actors linked to Aave Labs.

If the sentiment vote confirms this reception, the file will move to the ARFC stage, then possibly to an AIP vote on the chain. At this stage, the challenge will be to more precisely assess the risks, economic parameters and technical guarantees. If governance validates these steps, Bitcoin could gain a more direct place in DeFi credit markets, without immediately changing the rules of prudence expected by the protocol.