Babylon Labs Proposes Native Bitcoin Collateral for Aave V4

Aave DAO, a decentralized governing body for the Aave Protocol, is now looking at a proposal from Babylon Labs that would bring native Bitcoin (BTC) into Aave V4 as loan collateral.

The proposal was submitted as a “temp check,” which means it is still in early discussion. The idea is simply to allow users to borrow against real Bitcoin without needing bridges, wrapped tokens, or custodians holding the BTC.

In an X post on Monday, Babylon Labs stated that it is asking for “community input on two new Aave V4 Spokes.” These two Spokes are called the Babylon Core Lending Spoke and the BTC Vault Swap Spoke. Together, they form the system that would connect Bitcoin on its own chain with borrowing on Ethereum.

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How the system would work

Under the proposal, users would be able to lock BTC directly on the Bitcoin network through Trustless Bitcoin Vaults. The BTC would remain secured on Bitcoin using Taproot-based scripts.

At the same time, a mirrored representation called vaultBTC would be created on Ethereum. According to the proposal, vaultBTC would not move actual Bitcoin onto Ethereum but would instead act as a cryptographic representation of BTC locked on the Bitcoin chain.

Users would then be able to use vaultBTC inside Aave V4 to borrow other assets such as stablecoins or wrapped BTC. If a loan goes bad and gets liquidated, the BTC Vault Swap Spoke would step in. It lets liquidators swap the seized BTC position into WBTC so they can settle quickly. Later, the real Bitcoin would be redeemed on the Bitcoin network through a proof system.

The Trustless Bitcoin Vault system is built so BTC never leaves Bitcoin. Instead of bridges or custodians, it uses cryptography. When BTC is locked, it can only be moved if a valid proof is shown from another chain, like Ethereum. 

According to Babylon Labs, the design also includes a challenge period that would allow invalid claims or fraudulent actions to be disputed before settlement.

Proposal comes after Aave-linked exploit

This proposal comes just a month after a major security incident hit Aave’s ecosystem in April 2025. On April 18, attackers widely linked to the Lazarus Group exploited a cross-chain bridge system on Kelp’s LayerZero infrastructure. They stole around 116,500 rsETH by faking cross-chain messages, tricking the system into accepting invalid tokens. 

The attacker then deposited the stolen rsETH into Aave and borrowed WETH against it. This created about $190 million in bad debt and forced risk teams to freeze activity across multiple markets, while panic withdrawals spread across DeFi lending platforms.

To contain the damage, a recovery coalition called DeFi United was formed. It raised over $300 million in ETH commitments from major ecosystem players, including Lido, Ether.fi, LayerZero, Mantle, and Aave founder Stani Kulechov. 

Aave and Kelp later burned the stolen rsETH on Arbitrum to prevent reuse. The Arbitrum DAO also approved the release of 30,766 frozen ETH to support recovery efforts, although part of the process is still under legal review in a U.S. federal court due to sanctions-related concerns.

After the exploit, Kelp also announced it would move its cross-chain system away from LayerZero and adopt Chainlink CCIP, stating that LayerZero’s previous verifier design was not strong enough for high-value transfers.

The Babylon Labs proposal remains open for governance feedback. If approved, it could expand Bitcoin’s role within decentralized lending markets while keeping BTC secured natively on the Bitcoin blockchain.

Also Read: Aave Upgrades Savings GHO to sGHO With Fixed 4.25% Yield