A co-founder of the Bitcoin infrastructure firm, Babylon Labs, has announced the development of a system that enables native Bitcoin to be utilized as trustless collateral for borrowing on the Ethereum blockchain.
In a post on X this Wednesday, David Tse, co-founder of Babylon Labs and a Stanford University professor, stated that the company has created a proof-of-concept that allows native Bitcoin (BTC) “to be used trustlessly as collateral to borrow on Ethereum for the first time.”
This announcement follows the early August release of a white paper outlining a Bitcoin trustless vault system. The system utilizes the Bitcoin smart contract verification mechanism BitVM3 to secure BTC in user-specific vaults, with withdrawals (redemption or liquidation) contingent on cryptographic proofs of external smart contract states verified on Bitcoin.
This innovation enables users to lock Bitcoin and transfer it to Ethereum without depending on a federated custodian or bridge. On the Ethereum side, a smart contract authenticates the BTC vault through a Bitcoin light client before calculating collateral.
An experimental version of the resulting token is currently available on the on-chain lending protocol Morpho, though it is still in the testing phase, with total market liquidity of $14 in USDC. Tse described VaultBTC as “an intermediate non-fungible asset that connects the vault with Morpho, enabling depositors and liquidators to trustlessly withdraw BTC.”
At the time of publication, Babylon Labs and Tse had not replied to Cointelegraph’s request for commentary.
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How trustless is it?
While certain aspects of the system are trustless, others are not. According to the white paper, the liquidation of Babylon’s Bitcoin vaults involves whitelisted liquidators supervising the price and vault state, leading to a system that is not entirely permissioned and introduces trust requirements.
Despite co-signing measures designed to mitigate censorship, the framework still presupposes that enough liquidators (and occasionally major lenders) will act correctly. While the design of the system prevents them from stealing Bitcoin, it still necessitates a trust assumption.
Liquidations depend on a price oracle, making them susceptible to the oracle’s accuracy, promptness, and resistance to censorship. If the oracle fails or is delayed, erroneous decisions occur. Oracle providers, such as Band Protocol and Pyth Network, did not respond to Cointelegraph’s request for comment by publication.
Related: The future of DeFi isn’t on Ethereum — it’s on Bitcoin
What really changes?
The white paper presents a straightforward scenario: “Bob possesses 1 BTC and wants to borrow $50,000 in a stablecoin from Larry through a lending protocol on Ethereum.” In this case, if Bitcoin’s value falls below $50,000, Larry has the right to liquidate the collateral. If Bob repays the loan as scheduled, he retrieves the BTC.
Babylon Labs indicates that existing systems involve multiple trust assumptions. Bob could choose to hand his Bitcoin to Larry for safekeeping, trusting he will return it.
Alternatively, Bob could retain his Bitcoin and allow Larry to liquidate it should its price drop — but this requires Larry to rely on Bob’s integrity. Lastly, Bob could bridge his Bitcoin to Ethereum as Wrapped Bitcoin (WBTC) and use it as collateral in a smart contract. However, he must place trust in the wrapping mechanism itself.
WBTC entails trust because its backing Bitcoin is held by a centralized custodian who must be relied upon not to lose, freeze, or mishandle the funds. Users depend on the custodian’s honesty and stability rather than cryptographic assurances. This issue is what Babylon’s trustless implementation aims to resolve.
“Trustless vaults remove all such trust assumptions. Bob and Larry jointly pre-sign a collection of Bitcoin transactions outlining conditional spending rights,” the white paper asserts.
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