Babylon Advances Native Bitcoin Collateral Plan for Aave V4

Babylon Labs advanced its plan to let Aave users borrow stablecoins against native bitcoin, publishing an Oct. 14, 2026 governance proposal that details how $BTC could remain on Bitcoin while supporting loans on Ethereum.

The proposal would add two modules, or Spokes, to Aave V4: a Babylon Spoke with native $BTC as its sole collateral asset, and a $BTC Vault Swap Spoke to handle liquidation settlement. Borrowers would draw loan assets from an Aave V4 Hub, which provides liquidity to the Spokes. Stablecoin borrowing is the first intended use.

The native-$BTC lending plan surfaced in May. Babylon says an earlier temperature check passed, but the new ARFC is a discussion-stage proposal, not approval to activate the market.

Native Collateral, Wrapped-$BTC Liquidations

Under Babylon's Trustless Bitcoin Vaults design, a depositor locks $BTC in a Taproot UTXO—a Bitcoin transaction output with programmed spending conditions—without wrapping, bridging or handing it to a custodian. Redemption follows onchain rules enforced by the integration on Ethereum and settles to an authorized Bitcoin address.

Aave V4 accepts ERC-20 collateral, so the integration would create an internal token representing the locked $BTC one-for-one. Unlike a tradable $BTC wrapper, that token could move only among the integration's designated contracts, not between users.

The design uses zero-knowledge proofs of Ethereum redemption events and a challenge window during which designated participants can stop invalid claims. Challengers include vault providers, application vault keepers and universal challengers. A depositor can operate their own vault provider rather than depend on another participant to challenge a fraudulent claim.

That design creates a timing problem: native $BTC redemption takes multiple days and is limited to actors named in advance in each vault's Bitcoin script. The proposed Swap Spoke would let other liquidators receive wrapped bitcoin (WBTC) immediately instead. It would borrow that WBTC from the Hub and hold the seized vaults until permissioned arbitrageurs buy and redeem them.

Liquidations would seize whole vaults, not fractions of a vault. If repaying all of a borrower's debt uses only part of a vault's value, the liquidator would still take the whole vault and compensate the borrower for the remainder in WBTC at the liquidation-bonus discount.

The Swap Spoke also specifies a loss path: if an escrowed vault no longer covers its debt to the Hub, an arbitrageur could buy it at its current value less a reserved margin, with the shortfall reported to the Hub as a deficit.

Risk Settings Still to Come

Full risk parameters are still to come from Aave's risk service providers. Aave DAO would govern both Spokes and set caps, liquidation parameters and oracle configuration. A separate Swap Spoke configuration role would sit with a two-of-three multisig comprising Llama Risk, Babylon Labs and Aave Labs.

Babylon governance representatives would control the vault protocol's configuration and participant sets. Its emergency pause could also stop exit paths; governance actions would run through a public timelock with advance onchain notice.

The next steps are community feedback and risk analysis, followed by a Snapshot vote if consensus emerges. A positive result would lead to an Aave Improvement Proposal with full risk parameters for onchain governance approval.