A co-founder of Bitcoin infrastructure firm, Babylon Labs, asserts they have developed a system that enables native Bitcoin to be utilized as trustless collateral for borrowing on the Ethereum blockchain.
In a Wednesday X post, Babylon Labs co-founder and Stanford University professor David Tse stated that the company has built a proof-of-concept enabling native Bitcoin (BTC) “to be utilized trustlessly as collateral for borrowing on Ethereum for the first time.”
These remarks follow the early August release of a white paper detailing what they describe as a Bitcoin trustless vault system. This system employs the Bitcoin smart contract verification mechanism BitVM3 to secure BTC in per-user vaults, with withdrawals (redemption or liquidation) governed by cryptographic proofs of external smart contract state verified on Bitcoin.
This innovative approach allows users to lock Bitcoin and bridge it to Ethereum without the need for a federated custodian or bridge. On the Ethereum side, a smart contract verifies the BTC vault through a Bitcoin light client prior to collateral accounting.
An experimental version of the resultant token is already available on the on-chain lending protocol Morpho. However, it is still in the testing phase, with a total market liquidity of $14 in USDC. Tse described VaultBTC as “an intermediate non-fungible asset that bridges the vault with Morpho and facilitates trustless withdrawals of BTC for depositors and liquidators.”
Babylon Labs and Tse had not responded to Cointelegraph’s inquiry for comment by the time of publication.
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How trustless is it?
While the previously described component of the system operates trustlessly, certain aspects remain non-trustless. According to the white paper, Babylon’s Bitcoin vault liquidations rely on whitelisted liquidators to monitor price and vault conditions, resulting in a liquidation process that is not fully permissionless, introducing trust assumptions.
Even with the co-signing mechanism intended to mitigate censorship, the model still depends on sufficient liquidators (and occasionally large lenders) behaving appropriately. Although they cannot misappropriate Bitcoin due to the system’s architecture, this still introduces a trust assumption.
Liquidation processes depend on a price oracle, thus inheriting risks related to the oracle’s accuracy, timeliness, and resistance to censorship. Should the oracle provide incorrect or delayed information, the system may make erroneous decisions. Oracle providers with existing ties to Babylon Labs, Band Protocol and Pyth Network, had not responded to Cointelegraph’s request for comment by the time of publication.
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What really changes?
The white paper provides a straightforward example: “Bob possesses 1 BTC and wishes to borrow $50,000 in stablecoin from Larry using a lending protocol on Ethereum.” This implies that if Bitcoin’s value drops below $50,000, Larry is entitled to liquidate the collateral, and if Bob repays the loan punctually, he retrieves the BTC.
Babylon Labs clarifies that existing systems involve multiple trust assumptions. Bob can transfer his Bitcoin to Larry for safekeeping, trusting him to return it.
Alternatively, Bob can retain the Bitcoin and agree to permit Larry to liquidate it if the price plummets — but that would require Larry to trust Bob’s integrity. Lastly, Bob could convert Bitcoin to Ethereum as Wrapped Bitcoin (WBTC) and employ it within a smart contract as collateral. However, he would still need to trust the wrapping mechanism itself.
WBTC necessitates trust, as the Bitcoin backing it is managed by a centralized custodian who must be trusted to avoid losing, freezing, or misusing the funds. Users rely on this custodian’s honesty and financial health instead of cryptographic assurances. This is the core issue addressed by Babylon’s trustless solution.
“Trustless vaults eliminate all such trust assumptions. Bob and Larry collaboratively pre-sign a series of Bitcoin transactions that specify conditional spending rights,” states the white paper.
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