Key points
- Babylon proposes introducing native Bitcoin collateral in Aave V4
- During the loan period, BTC will remain locked on the Bitcoin network.
- Governance controls and liquidation mechanisms are facing increased scrutiny.
According to a new proposal by Babylon Labs, Bitcoin holders may soon be able to borrow stablecoins through Aave without moving their BTC off the Bitcoin blockchain. This proposal would expand one of the largest lending platforms in the decentralized finance ecosystem.
In a governance proposal released on October 14, Babylon outlined an integration scheme where users can lock native Bitcoin in a specialized Taproot vault while borrowing stablecoins through Aave V4.
Unlike traditional DeFi lending that uses Bitcoin as collateral, this model typically relies on wrapped BTC as a mapped asset, while the underlying collateral under this proposal will remain on the Bitcoin network. The proposal has passed the initial community temperature check but still requires further risk assessment and governance approval.
How Aave accepts Bitcoin without bridging it
The proposed system uses Babylon’s Trustless Bitcoin Vaults (TBV) to connect Bitcoin collateral with Aave’s Ethereum-based lending infrastructure.
Users will first lock their BTC in a Taproot transaction output on the Bitcoin network. Subsequently, Aave V4 will generate a corresponding record representing this collateral, enabling borrowers to obtain stablecoin liquidity without transferring the underlying tokens to Ethereum.
This design introduces two components: Babylon Spoke, which manages BTC collateralized lending and borrowing, and BTC Vault Swap Spoke, which supports liquidation and settlement.
Since Aave V4 generally accepts ERC-20 collateral, this integration will still create a restricted accounting token to represent the Bitcoin vault. However, this token cannot be freely traded or transferred like traditional wrapped BTC.
This proposal builds on Babylon’s early Bitcoin staking program, which previously sought to expand the use of BTC beyond mere holding and value transfer.
Babylon stated that since August 2024, its existing staking infrastructure has activated over 100,000 BTC, indicating market demand for Bitcoin financial applications.
Governance issues surrounding Bitcoin collateral are emerging.
Although the system avoids transferring native BTC into a custodial cross-chain bridge, its withdrawal mechanism introduces additional considerations.
On October 16, a governance participant questioned whether the emergency mechanism controlled by Babylon could still prevent users from withdrawing their collateral, even if Bitcoin remains securely stored in the vault.
Babylon engineer Aleksa Opacic responded that the emergency pause mechanism cannot transfer or release BTC, but can temporarily block withdrawals, repayments, and liquidations.
According to Babylon, emergency control will involve a temporary governance multisig requiring 4 out of 7 signatures, along with an emergency guardian group requiring 3 out of 5 signatures. Contract upgrades will require a 5-day lock period, while emergency pauses can be executed immediately.
These distinctions matter because collateral security does not automatically ensure that users can continuously and uninterrupted access the associated assets, especially during market volatility when borrowers must maintain adequate collateralization ratios.
Previous Aave liquidation cases have demonstrated that complex collateral arrangements and interconnected lending infrastructure can lead to real financial consequences.
Earn new income through lending or borrowing with Aave or BTC.
The integration proposal also outlines a revenue-sharing arrangement between Aave DAO and Babylon Foundation.
Under the initial structure, Aave will first receive the first $500,000 of eligible annual revenue. Any revenue exceeding this threshold will be distributed among Aave, Babylon, and token purchase allocations according to a multi-tiered mechanism.
At higher income levels, a portion of the allocation will be used to purchase AAVE and BABY on the market, but the proposal does not guarantee that borrowing demand will materialize or that token purchases will definitely occur.
This development comes as institutional interest in Bitcoin-collateralized lending continues to grow, and Aave expands its V4 lending architecture.
Meanwhile, Bitcoin-backed loan products offered by institutions like Strike demonstrate how different providers are balancing liquidity against liquidation risk.
Author Maya Bennett is a financial journalist who has covered cryptocurrency, equities, and broader market trends. Her reporting focuses on Bitcoin, major digital assets, stock markets, monetary policy, and economic developments that influence investor sentiment.