Aave Considers Onboarding Native Bitcoin Collateral via Babylon Protocol

Babylon Labs submitted an Aave Request for Final Comments (ARFC) to activate native $BTC as collateral on Aave V4, following a temperature check on the integration ¹². The proposal introduces Babylon's Trustless Bitcoin Vaults (TBV) protocol to allow users to lock Bitcoin natively in Taproot UTXOs and borrow host-chain assets, starting with stablecoins on Ethereum ¹². At the time of writing, $AAVE traded down 5.6% over 24 hours at $150.32, while Bitcoin was down 2.5% at $81,203.

The deployment adds two custom modules to Aave V4's Hub-and-Spoke architecture: the Babylon Core Lending Spoke and the BTC Vault Swap Spoke ¹. Because Aave V4 requires ERC-20 collateral, the integration uses an 8-decimal, transfer-restricted accounting token representing locked Bitcoin vaults 1:1, non-tradable and limited strictly to protocol contracts ¹². Babylon's TBV framework relies on zero-knowledge proof verification through the BaBe protocol developed with UC Berkeley, enabling off-chain host verification backed by fraud-proof challenge windows on the Bitcoin network ¹². Depositors can act as their own challengers, eliminating discretionary threshold multisigs, wrapped assets, or third-party custodians ¹².

Liquidation and Wrapped Reserves

To reconcile Bitcoin's settlement latency with immediate DeFi liquidations, the proposal incorporates an isolated swap spoke ¹². When a borrower's health factor drops, permissionless liquidators seize the underlying vault by receiving wrapped Bitcoin ($WBTC) pulled from the Aave V4 Hub at a bonus ¹². A permissioned group of arbitrageurs then settles the hub's WBTC debt before redeeming the original Taproot UTXO on the Bitcoin blockchain ¹². Babylon noted this loop creates active borrow demand for Aave's existing WBTC reserves, which exceed $5 billion in deposits but face underutilized borrowing capacity ¹².

Babylon Labs was founded in 2022 by Stanford Professor David Tse and Dr. Fisher Yu, raising more than $110 million from investors such as Paradigm, Polychain, and a16z ². Its core Bitcoin staking system secures other networks, with active balances totaling 40,772 BTC (approximately $3.37 billion) ². Ongoing audits across TBV are being conducted by Coinspect, Sherlock, Zellic, ABDK, and ZK Security, alongside formal verification by Runtime Verification ¹. Aave's independent risk service providers will specify collateral factors, caps, and interest parameters before moving the integration to an on-chain DAO vote ¹².