The co-founder of Bitcoin infrastructure company Babylon Labs claims to have built a system that allows native Bitcoin to be used as trustless collateral for borrowing on the Ethereum blockchain.
In a post on X on Wednesday, Babylon Labs co-founder and Stanford University professor David Tse claimed that Babylon has built a proof of concept that allows native Bitcoin (BTC) to be “trustlessly used as collateral for borrowing on Ethereum for the first time.”
The comments follow a white paper released by Babylon in early August outlining what it calls a Bitcoin trustless vault system. The system leverages the Bitcoin smart contract validation system BitVM3 to lock BTC into per-user vaults. Withdrawals (redemptions or liquidations) are gated by cryptographic proof of external smart contract state verified in Bitcoin.
This allows users to lock and bridge Bitcoin to Ethereum without relying on federation administrators or bridges. On the Ethereum side, the smart contract validates the BTC vault via the Bitcoin Lite client before calculating the collateral.
An experimental version of the resulting token is already available on the on-chain lending protocol Morpho. Still, it is still in the testing phase, with total market liquidity at $14 USDC (USDC). Tse described VaultBTC as “an intermediate non-fungible asset that interfaces between vaults and Morpho, allowing depositors and liquidators to withdraw BTC in a trustless manner.”
Babylon Institute and Tse did not respond to Cointelegraph’s requests for comment in time for publication.
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How unreliable is it?
Although the parts of the system described earlier are trustless, some parts remain non-trustless. According to the white paper, Babylon Bitcoin Vault Liquidation utilizes whitelisted liquidators to monitor prices and vault status, resulting in an unauthorized clearing system and introducing a trust assumption.
Even with co-signatures aimed at curbing censorship, this model still assumes that a sufficient number of liquidators (and in some cases large lenders) behave correctly. This introduces an assumption of trust into the system, even if the Bitcoin cannot be stolen thanks to the system design.
Clearing is dependent on price oracles and therefore inherits the risks of oracle accuracy, timeliness, and censorship resistance. If the oracle is wrong or late, the system will make the wrong call. The Oracle provider, which has existing relationships with Babylon Labs, Band Protocol, and Pyth Network, did not respond to Cointelegraph’s requests for comment by the time of publication.
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What really changes?
The white paper provides a simple example. “Bob holds 1 BTC and wants to borrow $50,000 in stablecoin from Larry via Ethereum’s lending protocol.” To do so, if the price of Bitcoin falls below $50,000, Larry can liquidate the collateral and should recover the BTC if Bob repays the loan on time.
Babylon Labs explains that current systems require many assumptions of trust. Bob can give the Bitcoin to Larry for safekeeping, believing that Larry will give it back.
If not, Bob could hold the Bitcoin and promise to let Larry liquidate it if the price drops, but Larry would trust Bob to keep his promise. Finally, Bob can bridge his Bitcoin to Ethereum as Wrapped Bitcoin (WBTC) and use it as collateral in a smart contract. Still, he will need to trust the wrapping mechanism itself.
WBTC requires trust. This is because the Bitcoins that back WBTC are held by a central custodian who must be trusted not to lose, freeze, or misuse the funds. Users rely on the honesty and solvency of this administrator, not on the guarantee of encryption. This is the main issue addressed by Babylon’s trustless implementation.
“Trustless vaults eliminate all such trust assumptions. Bob and Larry jointly pre-sign a series of Bitcoin transactions that define conditional spending rights,” the whitepaper states.
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