Babylon wants Aave users to borrow against Bitcoin

Babylon Labs has submitted a new governance proposal on October 14, 2026, to allow Bitcoin holders to borrow stablecoins through Aave V4 without selling their BTC, moving their coins to another blockchain, or handing them to a custodian.

Babylon Labs published the proposal on Aave’s governance forum, advancing an integration first discussed in May. The plan would introduce two dedicated components for Bitcoin backed borrowing and loan liquidations. The integration still requires community approval, finalized lending risk settings, and further security checks before launch.

Babylon proposes Bitcoin lending without wrapping BTC

The proposal introduces Babylon’s Trustless Bitcoin Vaults technology to Aave V4, the latest version of the decentralized lending protocol.

Under the proposed system, Bitcoin holders would deposit BTC into special vaults operating directly on the Bitcoin blockchain. Their coins would remain locked on Bitcoin while supporting loans issued through Aave.

Borrowers could then access stablecoins against the value of their deposited Bitcoin, subject to the lending rules and collateral requirements eventually approved by Aave governance.

The process differs from Aave’s existing Bitcoin lending arrangements, which support assets such as Wrapped Bitcoin (WBTC) and Coinbase Wrapped Bitcoin (cbBTC).

Wrapped Bitcoin products are tokens issued on another blockchain to represent BTC held through a separate arrangement. Their ownership and custody structures depend on the product involved.

Babylon proposes avoiding that structure by keeping the original BTC on Bitcoin throughout the loan.

The technology uses Bitcoin’s Taproot system to restrict how deposited coins can move. Transactions involving the vault must satisfy predetermined conditions before the locked BTC can be released.

Babylon’s proposal describes the process as “without transferring custody to any trusted third party.” Although the coins would remain on Bitcoin, Aave needs a way to recognize the collateral within its Ethereum based lending system.

Developers therefore propose a restricted ERC-20 accounting token representing each vault’s BTC value. The token would exist solely inside the integration. Users could not freely transfer, trade, or hold it outside the designated contracts.

Babylon specifies that the accounting token would represent locked BTC on a one to one basis. Its supply would increase when a vault becomes active and decrease when collateral leaves the lending position.

The earlier launch of Babylon’s Bitcoin vault technology introduced the protocol’s approach to using native BTC in decentralized finance without conventional custodial bridges.

Aave V4 would introduce two Bitcoin lending components

Babylon proposes creating two new components within Aave V4, known as Spokes.

The first, called the Babylon Spoke, would allow users to borrow supported assets against native Bitcoin collateral. The second, called the BTC Vault Swap Spoke, would handle a more complicated part of Bitcoin lending: liquidations.

A liquidation occurs when a borrower’s collateral value falls too far relative to the outstanding loan. The lending system can close some or all of the position to protect the funds borrowed from the protocol.

Traditional Aave liquidations generally involve assets already available on the same blockchain. Babylon’s proposed arrangement has an additional requirement because the underlying collateral sits on Bitcoin, while borrowing takes place through Aave.

According to the proposal, redeeming a Bitcoin vault can take several days because transactions must pass through a challenge period.

The BTC Vault Swap Spoke would allow liquidators to receive wrapped Bitcoin promptly while designated participants complete the underlying Bitcoin settlement.

WBTC is the initial wrapped asset proposed for that process.

The documents explain that the liquidation system would process individual Bitcoin vaults. A borrower holding several vaults could specify the order in which they would be used if liquidation became necessary.

Aave DAO would control the lending parameters, including borrowing limits, collateral requirements, interest rate settings and liquidation rules. 

Risk service providers would supply the proposed settings for the two components. The governance forum discussion received support from Aave founder Stani Kulechov, who described native Bitcoin as an important potential source of lending collateral.

He welcomed the plan and supported using Aave V4’s dedicated architecture for the integration. The development follows earlier reporting on Babylon’s $15 million investment from a16z, which described the company’s plans to expand from Bitcoin staking into lending services.

Aave DAO could receive the first $500,000 in annual fees

Babylon’s proposal includes a revenue sharing arrangement between Aave DAO and the Babylon Foundation.

Under the proposed terms, Aave DAO would receive all of the first $500,000 in qualifying annual revenue generated by the integration. The qualifying revenue would come from specified protocol fees, including Aave’s liquidity fee on borrowing interest and fees collected through liquidation activities.

The arrangement would not apply to every dollar of interest paid by borrowers. After the first $500,000, revenue would be distributed according to several annual bands.

For qualifying revenue between $500,000 and $2 million, Aave DAO would receive 78%, Babylon would receive 18%, and 4% would go toward token purchases.

Higher revenue bands would provide different distributions. At annual qualifying revenue above $6 million, the proposed allocations would be 61.5% for Aave DAO, 31.5% for Babylon, and 7% for token purchases.

The token purchase allocation would fund open market purchases of AAVE and BABY, with 85% directed toward AAVE and 15% toward BABY. Purchased tokens would be divided equally between Aave DAO and Babylon Foundation.

These figures describe a proposed revenue formula, not projected earnings. Babylon has not guaranteed that the integration would generate enough activity to reach any of the thresholds.

In the governance document, Babylon reported that its existing Bitcoin staking protocol had activated more than 100,000 BTC cumulatively since August 2024.

The company listed approximately 40,772 BTC as currently staked when the proposal was prepared, with an estimated value of $3.37 billion.

Those figures relate to Babylon’s existing staking activities and do not represent Bitcoin already deposited into the proposed Aave lending integration.

The expansion of Babylon’s Bitcoin staking services through Kraken previously introduced another route for eligible customers to participate in Bitcoin based network security.

Staking and the proposed lending integration are separate activities with different reward arrangements and financial risks.

Bitcoin lending proposal needs more votes and security reviews

The October 14 submission is an Aave Request for Comment, meaning community members and risk specialists can review and discuss the plan.

Babylon initially introduced the integration through a Temperature Check proposal on May 25.

That preliminary proposal passed a community vote in June, allowing developers to prepare the more detailed October submission.

The current stage does not authorize the integration to launch.

According to Aave’s governance rules, a proposal advancing from the discussion stage can move to an offchain Snapshot vote before reaching formal onchain governance.

For the relevant Snapshot process, the proposal requires at least 320,000 AAVE equivalent votes in support. The final onchain vote must satisfy its own participation and approval requirements.

Babylon has not announced when those votes will take place.

The proposal describes security reviews conducted across five areas: Bitcoin vaults, proof generation, smart contracts, web services and the cryptographic system supporting vault settlements.

Six security firms participated in the audit work, including Coinspect, Sherlock, Zellic, ABDK, ZK Security and Runtime Verification.

Babylon states that each component received at least two independent reviews. Runtime Verification performed formal verification work on the smart contracts.

The company is now conducting another review of finalized changes with Coinspect, ABDK and Zellic before any mainnet deployment.

Babylon has committed to publishing the follow up reports when that work is completed.

The next formal steps listed in the October 14 proposal are community feedback and risk analysis, a possible Snapshot vote, and an Aave Improvement Proposal containing the complete risk settings for final onchain approval.