Babylon Labs is pushing forward a proposal that would let users take out loans on Aave V4 backed by Bitcoin, with the coins remaining on the Bitcoin network throughout. The plan entered Aave's formal governance process as an Aave Request for Comments, or ARFC, published on the protocol's governance forums, according to KuCoin.
The native Bitcoin collateral proposal matters because using BTC in DeFi lending has historically meant wrapping it and trusting a custodian to hold the underlying coins, a tradeoff that has kept many long-term holders on the sidelines. Babylon's design aims to remove that objection by keeping the BTC on its own chain while Aave treats it as collateral.
How the Native Bitcoin Collateral Design Works
The proposal is built on Babylon's Trustless Bitcoin Vaults protocol, or TBV. Rather than converting BTC into a wrapped token on a different chain, TBV secures the coins inside self-custodial Taproot UTXOs on Bitcoin itself, with rules enforced through Taproot scripts and zero-knowledge proofs, Crypto Briefing reported.
The BTC stays put on its home chain and is not entrusted to any multisig committee, a departure from conventional centralized custody models and federated bridges, according to KuCoin. On Ethereum, the system does not issue a tradable synthetic token; instead, developers say it relies on an ERC-20 contract whose transfers are tightly restricted, functioning only as a 1:1 internal accounting unit that just the central Hub and Aave V4 adapter contracts can access.
Aave V4 recognizes only ERC-20 tokens as collateral, so Babylon would issue one internal token for each bitcoin locked, used only within the lending system with no ability for users to trade or transfer it, Digital Today reported. Cointelegraph described the same structure, noting the collateral would be represented by a non-transferable token on Ethereum, while the BTC itself remains on its native blockchain without being bridged or wrapped.
Verification across the two chains is handled cryptographically by the BaBe protocol, developed jointly by Babylon Labs and UC Berkeley researchers, according to KuCoin. A technical paper registered under reference eprint 2026/065 says the optimization cuts SNARK proof verification costs on Bitcoin by roughly 1,000 times compared to prior approaches.
Two New Aave V4 Spokes
The design draws on Aave V4's modular architecture, which splits markets into building blocks known as spokes, and the proposal calls for adding two of them. The first is the Babylon Spoke, which serves as the main venue where only native BTC is accepted as collateral, drawing borrowing liquidity from the Aave V4 Hub, according to KuCoin.
There, borrowers would supply vault-backed BTC and draw out assets including USDC, USDT and WBTC. The second module, the BTC Vault Swap Spoke, handles the resolution and liquidation of undercollateralized positions while avoiding long delays on the Bitcoin mainnet.
Liquidations are the hard part of the design. DeFi liquidations normally have to settle right away, but releasing scripts on Bitcoin carries multi-day challenge windows that are checked with zero-knowledge proofs, according to KuCoin. To bridge that gap, permissionless liquidators would be paid in Wrapped BTC, initially WBTC, drawn as debt from the Aave Hub, while a designated pool of arbitragers later takes over vault buybacks and redemptions on the Bitcoin blockchain.
That structure means liquidators get a familiar asset they can use right away on Ethereum, while borrowers never had to wrap anything going in, Crypto Briefing reported. Documentation covering the liquidation model is available in Babylon's developer docs.
Revenue Terms and Security Reviews
On economics, the plan lays out tiered brackets for splitting qualified revenue between Aave DAO and the Babylon Foundation. Under the proposal, 100% of the first $500,000 generated annually would go to Aave DAO, after which tiered percentages would apply, including allocations for open-market purchases of AAVE (85%) and BABY (15%) tokens, according to KuCoin.
The proposal text contends the setup would generate ongoing borrowing demand for Aave's existing WBTC pools, where utilization on the borrowing side is currently low, KuCoin reported. Crypto Briefing noted that Aave holds one of its largest token supplies in WBTC, and because liquidators get paid in WBTC and borrowers can take out WBTC, the integration could potentially put more of that idle supply to work.
On security, the framework says six independent security firms have finished audits, with Runtime Verification carrying out formal verification of the smart contracts, according to KuCoin. The technical roadmap schedules final re-audits by Coinspect, ABDK and Zellic before the binding governance vote and mainnet deployment.
Babylon has built an operational track record starting with its staking system in August 2024, accumulating over 100,000 BTC in total and currently holding approximately 40,772 BTC under management, valued at around $3.37 billion, according to protocol records cited by KuCoin.
Governance Path and What Comes Next
Babylon and Aave first announced their partnership on December 3, 2025. The idea moved into Aave's formal process with a DAO temperature check that began on May 25, 2026, and a preliminary community vote passed on June 10, according to Babylon Labs, as reported by Cointelegraph. A public testnet deployment for native BTC-backed borrowing was active by October 2026, and HashKey Cloud's integration of TBV for institutional clients was confirmed on October 7, 2026.
As of Thursday, the proposal remains at the ARFC stage, where it faces community feedback and risk analysis, Cointelegraph reported. If consensus is reached, it can proceed to a three-day offchain Snapshot vote requiring at least 320,000 AAVE-equivalent votes in favor, before advancing to a formal onchain vote that must meet quorum and approval requirements under Aave's governance rules.
Risk parameters still need to be set, and more Aave DAO votes are required before anything goes live on mainnet. Control over risk settings stays with the Aave DAO: Babylon builds the plumbing, but tokenholders decide how much can be borrowed and when positions get closed out, Crypto Briefing reported.
Loan-to-value ratios, liquidation thresholds and supply caps will determine whether the native Bitcoin collateral market becomes a niche experiment or a serious Bitcoin borrowing venue. Conservative settings would limit early risk but also limit appeal, while aggressive ones would attract borrowers while putting more weight on the untested liquidation path, according to Crypto Briefing.
Wrapped Bitcoin products have long dominated BTC collateral in DeFi, and a credible native alternative on the largest lending protocol would put pressure on custodial models to justify their trust assumptions. Whether that happens now depends on further rounds of DAO voting.
Conclusion
Babylon Labs' proposal to bring native Bitcoin collateral to Aave V4 has advanced to the ARFC stage, with a design that keeps BTC locked on the Bitcoin network while liquidators are paid in WBTC. The plan still requires defined risk parameters, final re-audits by Coinspect, ABDK and Zellic, a Snapshot vote and a binding onchain vote before any mainnet launch. Control over the decisive settings remains with the Aave DAO.
Frequently Asked Questions
What is Babylon's native Bitcoin proposal on Aave V4?
Babylon Labs has submitted an ARFC proposal to let users borrow assets such as stablecoins on Aave V4 against native BTC. The Bitcoin stays locked in self-custodial Taproot vaults on the Bitcoin network, while a non-transferable internal token on Ethereum represents the collateral for Aave's system.
How would liquidations work if the BTC stays on the Bitcoin network?
A second module, the BTC Vault Swap Spoke, handles liquidations. Permissionless liquidators would receive WBTC immediately, borrowed as debt from the Aave Hub, while designated arbitragers later handle vault buybacks and redemptions on Bitcoin, bridging the gap between instant DeFi liquidations and Bitcoin's multi-day challenge windows.
What revenue would Aave DAO receive from the Babylon integration?
Under the proposal, Aave DAO would receive 100% of the first $500,000 in qualifying annual revenue generated by the integration. After that threshold, tiered percentages would apply, including allocations for open-market purchases of AAVE (85%) and BABY (15%) tokens, according to KuCoin.
What governance steps remain before native BTC borrowing launches on Aave?
The proposal is at the ARFC stage, facing community feedback and risk analysis. If consensus forms, it moves to a three-day Snapshot vote requiring at least 320,000 AAVE-equivalent votes in favor, then a formal onchain vote that must meet quorum and approval requirements. Risk parameters and final re-audits must also be completed.
When did Babylon and Aave first partner on Bitcoin collateral?
Babylon and Aave announced their partnership on December 3, 2025. A DAO temperature check began on May 25, 2026, followed by a preliminary community vote that passed on June 10, according to Babylon Labs. A public testnet for native BTC-backed borrowing was active by October 2026.
Sources
- Babylon advances native Bitcoin collateral plan for Aave V4
- Babylon Proposes Trustless Bitcoin Collateral for Aave V4 via ARFC
- Aave Integrates Native Bitcoin as Collateral for DeFi Users
- Babylon Labs proposes bitcoin-collateral loans for Aave V4
- Babylon advances native Bitcoin lending proposal on Aave V4
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