Babylon Labs, a blockchain and cryptocurrency infrastructure company, has proposed integrating native Bitcoin collateral into Aave V4 through its Trustless Bitcoin Vaults (TBV) protocol, allowing users to borrow supported assets against BTC without transferring the underlying cryptocurrency to a custodian or bridge.
The proposal, published on Aave’s governance forum on October 14 as an Aave Request for Comment (ARFC), introduces two new components: the Babylon Spoke and the BTC Vault Swap Spoke. The first would allow users to borrow against native Bitcoin, while the second would facilitate the settlement of liquidated BTC collateral.
The integration would make native BTC the sole collateral asset on the proposed Babylon Spoke. Stablecoins are the initial borrowing use case, although the assets available for borrowing would depend on Aave’s configuration and governance decisions.
The proposal remains subject to Aave governance review and approval. Risk parameters for both Spokes would be supplied by Aave’s risk service providers, while Aave DAO would retain control over asset listings, borrowing limits, interest rate strategies, and liquidation settings.
Babylon proposes self-custodial Bitcoin lending
The proposed integration uses Babylon’s Trustless Bitcoin Vaults to allow BTC holders to lock their assets directly on the Bitcoin network while using them as collateral on Aave V4. Under the mechanism, users deposit Bitcoin into a Taproot-based transaction output, creating a BTCVault. The vault’s spending conditions are established through a pre-signed transaction structure, with cryptographic proofs used to verify events on the host blockchain.
For the proposed Aave integration, Ethereum would serve as the initial host chain. When Bitcoin is locked, a corresponding collateral record is created on Ethereum to track the vault’s amount, depositor, and lifecycle status.
Aave V4 currently accepts ERC-20 tokens as collateral. To accommodate native Bitcoin, the integration would use a transfer-restricted ERC-20 representation of the BTCVault. The token would function as an internal accounting unit rather than a tradable wrapped Bitcoin asset.
According to the proposal, the representation token would not be transferable between users or usable outside the integration. Its supply would correspond to the amount of Bitcoin locked in active vaults.
The underlying BTC would remain locked on Bitcoin rather than being held by a conventional custodian, bridge, or threshold-signature group. However, the system would still depend on its cryptographic verification process, pre-authorized transaction structure, and participating vault actors.
HashKey Cloud plans Bitcoin-backed borrowing through Aave
The proposal comes after Babylon Labs and HashKey Cloud announced on October 7 that HashKey Cloud would integrate Trustless Bitcoin Vaults to offer native Bitcoin-backed borrowing and yield services. The planned integration will allow HashKey clients to use Bitcoin as collateral for borrowing through Aave V4 without wrapping or bridging their BTC or relying on a centralized custodian.
The arrangement is designed to connect Bitcoin holdings with Ethereum-based lending liquidity, giving users access to stablecoins and other assets supported by Aave V4. HashKey clients will also be able to deploy borrowed stablecoins into yield strategies.
Previously, Babylon has also partnered with hardware wallet manufacturer Ledger to let Bitcoin holders use Trustless Bitcoin Vaults while approving transactions directly through Ledger devices using its Clear Signing system.
Two new Aave V4 spokes handle borrowing and liquidation
The proposal introduces two Spokes to manage borrowing against Bitcoin and the settlement of collateral during liquidations. The Babylon Spoke would allow users to borrow assets from an Aave V4 Hub against their BTCVault positions. Borrowing and repayment would follow Aave’s existing mechanics, with the adapter managing collateral deposits, withdrawals, and position updates.
The second component, the BTC Vault Swap Spoke, addresses a complication arising from Bitcoin’s settlement process. When a borrower becomes eligible for liquidation, the protocol allows liquidators to seize BTCVaults. However, redeeming the underlying Bitcoin requires a separate process involving authorized participants and a challenge period that can take multiple days.
The BTC Vault Swap Spoke is designed to separate the liquidation process from the eventual Bitcoin redemption. Under the proposed mechanism, a permissionless liquidator could exchange a seized BTCVault for wrapped Bitcoin, initially WBTC, at an oracle-based rate adjusted by a discount. The WBTC would be borrowed from an Aave V4 Hub and held as interest-accruing debt against the escrowed BTCVault.
Authorized arbitrageurs could subsequently acquire the escrowed vaults by repaying the outstanding WBTC debt, including accrued interest, and redeem the underlying Bitcoin on the Bitcoin network. This structure would allow liquidators to receive a fungible asset without waiting for the Bitcoin redemption process to finish.
Liquidation rules account for Bitcoin settlement delays
The proposal modifies Aave’s standard liquidation process to account for the fact that BTCVaults represent individual Bitcoin transaction outputs and cannot be divided into smaller units. Each liquidation would target one BTCVault at a time. If a position contains multiple vaults, liquidators could make repeated calls until the position returns to a healthy state or its debt is repaid.
The borrower could establish the order in which individual vaults are seized. The adapter would manage the process and ensure that liquidation follows the position’s configured rules.
The proposal also describes two liquidation routes. In the permissioned route, an application vault keeper with redemption rights could liquidate a position and redeem the seized Bitcoin directly. In the permissionless route, an external liquidator would use the BTC Vault Swap Spoke to exchange the seized vault for wrapped Bitcoin.
If a liquidation results in the seizure of more collateral than required to repay the outstanding debt, the remaining value would be returned to the borrower in wrapped Bitcoin, subject to the mechanism’s liquidation discount.
The proposed Spoke would use configurable parameters for the sale discount, the minimum profit reserved for arbitrageurs, and the fee recipient.
Aave DAO would control risk parameters and asset listings
Aave DAO would retain control over the main risk and market parameters governing the two Spokes. These include collateral and borrowing limits, interest rate strategies, liquidation parameters, and oracle configurations. The DAO could also freeze or pause individual assets, restricting new activity or stopping operations when necessary.
A separate 2-of-3 multisig involving Llama Risk, Babylon Labs, and Aave Labs would hold a configuration role for the BTC Vault Swap Spoke. Babylon’s own governance representatives would manage the underlying TBV protocol configuration, including participating actor sets and emergency controls. The proposal distinguishes between freezing the system, which would prevent new vault creation and borrowing while preserving exit routes, and pausing it, which would also suspend exit operations.
The proposed architecture therefore separates control over Aave’s lending markets from the governance of the underlying Bitcoin vault infrastructure.
Proposal outlines revenue sharing and token buybacks
The ARFC also includes a revenue-sharing arrangement between Aave DAO and Babylon Foundation. The arrangement applies to specified protocol-level fees rather than all interest paid by borrowers. Qualifying revenue includes Aave Hub liquidity fees generated by Babylon Spoke borrowing and liquidation fees collected through the adapter and BTC Vault Swap Spoke.
Under the proposed structure, the first $500,000 in annual qualifying revenue would go entirely to Aave DAO. For revenue above that threshold, the allocation would change across successive annual revenue bands. The proposal also includes allocations for open-market purchases of AAVE and BABY tokens. The token-purchase allocation would be divided 85% for AAVE and 15% for BABY, with purchased tokens allocated equally between Aave DAO and Babylon Foundation.
These arrangements are contingent on the integration’s implementation and the generation of qualifying revenue. The proposal does not guarantee borrowing demand, revenue, or token purchases.
Babylon outlines security reviews ahead of deployment
The proposal describes security reviews covering five components: the Bitcoin vaults, vault provers, smart contracts, web services, and BaBe, the cryptographic protocol used to verify claims.
Babylon said six firms were engaged in overlapping audit reviews, with each component receiving at least two independent reviews. Coinspect also conducted a preliminary review of the broader protocol, while Runtime Verification performed formal verification of the smart contracts. Babylon said it was conducting another round of audits on the finalized changes before mainnet deployment, involving Coinspect, ABDK, and Zellic. The corresponding reports would be shared once completed.
The integration’s security model relies on zero-knowledge proofs, a challenge-based verification process, and pre-signed Bitcoin transactions. During the redemption process, authorized participants submit proofs of events on Ethereum, while eligible challengers can dispute invalid claims during a designated window.
The proposal does not establish a deployment date. Its implementation depends on Aave governance approval, the completion of the required security work, and the configuration of the two Spokes.
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