Cointelegraph by Adrian Zmudzinski
A co-founder of Bitcoin infrastructure company, Babylon Labs, claims to have built a system that allows for native Bitcoin to be used as trustless collateral to borrow on the Ethereum blockchain.
In a Wednesday X post, Babylon Labs co-founder and Stanford University professor David Tse claimed Babylon built a proof-of-concept allowing for native Bitcoin (BTC) “to be used trustlessly as collateral to borrow on Ethereum for the first time.”
The comments follow Babylon’s release of a white paper in early August, outlining what it calls a Bitcoin trustless vault system. The system leverages the Bitcoin smart contract verification system BitVM3 to lock BTC in per-user vaults, where withdrawals (redemption or liquidation) are gated by cryptographic proofs of external smart contract state verified on Bitcoin.
This allows users to lock Bitcoin and bridge it to Ethereum without relying on a federated custodian or bridge. On the Ethereum side, a smart contract verifies the BTC vault via a Bitcoin light client before accounting for collateral.
An experimental version of the resulting token is already available on the onchain lending protocol Morpho. Still, it is in the testing phase, with a total liquidity in the market of $14 in USDC (USDC). Tse described VaultBTC as “an intermediate non-fungible asset that interfaces the vault with Morpho and allows depositor and liquidators to trustlessly withdraw BTC.“
Babylon Labs and Tse had not responded to Cointelegraph’s request for comment by publication.
Related: Kraken launches Bitcoin staking with Babylon integration
How trustless is it?
While the previously explained part of the system is trustless, some parts remain non-trustless. Per the white paper, Babylon’s Bitcoin vault liquidations utilize whitelisted liquidators to monitor the price and vault state, resulting in a liquidation system that is not permissioned and introduces trust assumptions.
Even with co-signing meant to curb censorship, the model still assumes enough liquidators (and sometimes large lenders) behave correctly. Even if they cannot steal Bitcoin thanks to the system’s design, this introduces a trust assumption into the system.
Liquidations hinge on a price oracle, so they inherit the oracle’s accuracy, timeliness, and censorship-resistance risks. If the oracle is wrong or delayed, the system makes the wrong call. Oracle providers with existing relationships with Babylon Labs, Band Protocol and Pyth Network had not responded 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 provides a simple example: “Bob holds 1 BTC and wishes to borrow $50,000 in a stablecoin from Larry via a lending protocol on Ethereum.” This would necessitate that if Bitcoin’s price falls under $50,000, Larry can liquidate the collateral, and if Bob repays the loan on time, he recovers the BTC.
Babylon Labs explains that current systems require numerous trust assumptions. Bob can hand over the Bitcoin to Larry for safekeeping, trusting that he will return it.
Otherwise, Bob can keep the Bitcoin and promise to allow Larry to liquidate it if the price falls — but Larry would trust Bob to keep his word. Lastly, Bob could bridge Bitcoin to Ethereum as Wrapped Bitcoin (WBTC) and use it in a smart contract as collateral. Still, he would have to trust the wrapping mechanism itself.
WBTC requires trust because the Bitcoin backing it is held by a centralized custodian who must be trusted not to lose, freeze, or misuse the funds. Users depend on this custodian’s honesty and solvency rather than cryptographic guarantees. This is the primary issue addressed by Babylon’s trustless implementation.
“Trustless vaults eliminate all such trust assumptions. Bob and Larry jointly pre-sign a set of Bitcoin transactions defining conditional spending rights,” the white paper states.
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