On October 14, 2026, Babylon Labs submitted a new governance proposal that would allow Bitcoin holders to borrow stablecoins through Aave V4 without having to sell BTC, transfer the coins to another blockchain, or hand them over to a custodian.
Babylon published this proposal on the governance forum of Aave, advancing an integration plan that was first discussed by both parties in May. The scheme will introduce two specialized components for Bitcoin collateral lending and loan settlement. Before its launch, this integration still requires community approval, final determination of lending risk parameters, and completion of further security checks.
Babylon proposes to conduct Bitcoin lending without packaging BTC.
This proposal will introduce the Trustless Bitcoin Vaults technology of Babylon into Aave V4, which is the latest version of this decentralized lending protocol.
Under the proposed system, Bitcoin holders will deposit BTC into a special vault that runs directly on the Bitcoin blockchain. Their tokens will remain locked on the Bitcoin network, while also providing support for loans issued through Aave.
Subsequently, borrowers can borrow stablecoins using the value of Bitcoin they have deposited as collateral, subject to the lending rules and collateral requirements ultimately approved by Aave.
This process is different from the existing Bitcoin lending arrangements of Aave. The latter supports assets such as Wrapped Bitcoin ( WBTC ) and Coinbase Wrapped Bitcoin ( cbBTC ).
Packaging Bitcoin products refers to the issuance of tokens on another blockchain that represent BTC held through separate arrangements. The ownership and custody structure depend on the specific product.
Babylon suggests avoiding this structure and always keeping the original BTC unchanged on the Bitcoin network until the loan is completed.
This technology utilizes Bitcoin's Taproot system to restrict the manner in which deposited tokens can be moved. Transactions involving the vault must meet preset conditions, and the locked BTC must be released before the tokens can be accessible.
Babylon describes this process in the proposal as “without the need to transfer custody to any trusted third party.” Although these coins remain on the Bitcoin network, Aave still needs a way to identify these collateral in its Ethereum-based lending system.
Therefore, developers propose to use a restricted ERC-20 accounting token to represent the value of BTC in each vault. This token will only exist within the integration, and users will not be able to freely transfer, trade, or hold it outside of the designated contract.
Babylon indicates that this accounting token will represent the locked BTC in a 1:1 ratio. As the vault is activated, its supply will increase; when the collateral is removed from the lending position, its supply will decrease.
The Bitcoin vault technology previously launched by Babylon demonstrated how this protocol can utilize native BTC in decentralized finance without relying on traditional hosting bridges.
Aave V4 will introduce two Bitcoin lending components
Babylon proposes to create two new components within Aave V4, which will be named Spokes.
The first one, named Babylon Spoke, will allow users to borrow supported assets by using native Bitcoin as collateral. The second one, named BTC Vault Swap Spoke, will handle the more complex aspect of Bitcoin lending: liquidation.
Liquidation occurs when the value of the borrower's collateral declines significantly relative to the outstanding loan amount. The lending system can close some or all positions to protect the funds lent under the agreement.
Traditional Aave settlements usually involve assets that already exist on the same blockchain. The arrangement proposed in Babylon has additional requirements, as the underlying collateral is located on the Bitcoin network, while the borrowing is conducted through Aave.
According to the proposal, since transactions must go through a challenge period, redeeming a Bitcoin vault may take several days.
BTC Vault Swap Spoke will allow the liquidator to receive the packaged Bitcoin in a timely manner, while the designated participants will complete the underlying Bitcoin settlement.
WBTC is the packaging asset that was initially proposed for use in this process.
The file explanation states that the settlement system will process each Bitcoin wallet individually. If a borrower holds multiple wallets, they can specify the order in which they wish to use them during the settlement process.
Aave DAO will control lending parameters, including the maximum borrowing amount, mortgage requirements, interest rate settings, and liquidation rules.
The risk service provider will provide proposed parameters for these two components. The discussion on the governance forum has received support from Aave founder Stani Kulechov, who believes that native Bitcoin is a potential and important source of collateral for lending.
He welcomes this plan and supports the use of the specialized architecture of Aave V4 to complete the integration. This development follows a previous report that Babylon received a $15 million investment from a16z; at that time, Babylon indicated plans to expand from Bitcoin staking to lending services.
Aave DAO may receive up to $500,000 in fees for the first year.
The proposal of Babylon includes the revenue sharing arrangement between Aave DAO and Babylon Foundation.
According to the proposed terms, Aave DAO will receive the full amount of the first $500,000 in qualified income generated in the first year from this integration. The qualified income will come from designated protocol fees, including the liquidity fees charged by Aave for borrowing interest, as well as fees collected through settlement activities.
This arrangement does not apply to every dollar of interest paid by the borrower. After the first $500,000, the income will be distributed over several annual intervals.
When the qualified income ranges from $500,000 to $2 million, Aave DAO will receive 78%, Babylon will receive 18%, and another 4% will be used for token purchases.
Different distribution methods will be adopted for higher income brackets. If the annual qualifying income exceeds $6 million, it is proposed to distribute 61.5% to Aave DAO, 31.5% to Babylon, and 7% will be used for token purchases.
The token purchase funds will be used to buy AAVE and BABY on the public market, with 85% allocated to AAVE and 15% to BABY. The purchased tokens will be evenly divided between Aave DAO and Babylon Foundation.
These numbers describe the proposed revenue formula, not the expected earnings. Babylon does not guarantee that this integration will generate sufficient activity to reach any threshold.
In the governance document, Babylon indicates that its existing Bitcoin staking protocol has activated over 100,000 BTC since August 2024.
The company listed that at the time of proposal preparation, the current pledged amount was approximately 40,772 BTC, with a valuation of about 3.37 billion US dollars.
These numbers are related to the existing staking activities of Babylon and do not represent the bitcoins that have been deposited into the proposed Aave lending integration.
Babylon expands its Bitcoin staking services through Kraken. Previously, it had already provided eligible customers with another way to contribute to the security of the Bitcoin network.
Pledge and the proposed lending integration are different activities, with different reward arrangements and financial risks.
The Bitcoin lending proposal still requires more voting and security reviews.
The content submitted on October 14th was a request for feedback from Aave, which means that community members and risk experts can review and discuss this plan.
Babylon Initially proposed this integration on May 25th through the Temperature Check initiative.
This preliminary proposal was approved by community voting in June, allowing developers to prepare a more detailed version to be submitted in October.
Integration is not authorized for launch at this stage.
According to the governance rules of Aave, proposals that progress from the discussion stage can first enter the off-chain Snapshot voting process, and then proceed to formal on-chain governance.
In the relevant Snapshot process, this proposal requires at least 320,000 AAVE equivalent support votes. The final on-chain voting must also meet its own participation and approval requirements.
Babylon has not yet announced when these votes will take place.
The proposal describes security reviews covering five areas: Bitcoin wallets, proof generation, smart contracts, network services, and cryptographic systems that support wallet settlements.
A total of six security companies participated in the audit work, including Coinspect, Sherlock, Zellic, ABDK, ZK Security, and Runtime Verification.
Babylon indicates that each component has undergone at least two independent reviews. Runtime Verification also includes formal verification of the smart contracts.
The company is currently in another round of review with Coinspect, ABDK, and Zellic regarding the final modifications before considering going live on the mainnet.
Babylon promises to release a follow-up report after the completion of this work.
The next official steps outlined in the proposal on October 14th include community feedback and risk analysis, a possible Snapshot vote, as well as a Aave improvement proposal that contains complete risk parameters and is intended for final on-chain approval.
