Babylon Labs says its new system enables native Bitcoin to be used as collateral on Ethereum without traditional custodial risk. However, questions remain over how truly trustless the model is.
Bitcoin as Trustless Collateral on Ethereum
Babylon Labs, a Bitcoin infrastructure firm, has unveiled a proof-of-concept that allows native Bitcoin to be used as collateral for borrowing on the Ethereum blockchain. Co-founder and Stanford professor David Tse announced that Bitcoin could now be deployed “trustlessly” in Ethereum lending protocols for the first time.
The innovation relies on BitVM3, a Bitcoin smart contract verification method, to lock BTC in individual vaults. Withdrawals, whether for redemption or liquidation, are only executed after cryptographic proofs verify the external smart contract state on Bitcoin.
This approach allows users to bridge Bitcoin to Ethereum without relying on federated custodians or conventional token wrapping mechanisms such as Wrapped Bitcoin (WBTC). On Ethereum, a smart contract checks the vault status using a Bitcoin light client before treating it as collateral.
An experimental version of the system, known as VaultBTC, is already listed on the lending protocol Morpho. At present, it holds only limited liquidity, with around $14 in USDC as testing continues.
How the Trustless Vault Works
VaultBTC functions as a non-fungible asset that links the user’s Bitcoin vault to Ethereum-based lending platforms. Depositors and liquidators can interact with the system and, in theory, withdraw Bitcoin without trusting an intermediary.
The key difference lies in the removal of custodial control. Rather than handing over Bitcoin to a central entity or relying on bridge operators, users pre-sign conditional Bitcoin transactions. These signatures define how and when funds can be moved, enforced entirely through cryptographic rules.
Remaining Trust Assumptions
Despite claims of full trustlessness, parts of the system still introduce reliance on human actors. According to Babylon’s white paper, the liquidation process depends on whitelisted liquidators. These designated participants are responsible for monitoring Bitcoin prices and vault conditions. While they cannot seize funds illegitimately, their role introduces a permission element and behavioural assumptions.
Even with co-signatures designed to prevent censorship, the system expects a sufficient number of liquidators and large lenders to act correctly. If they fail to do so, the liquidation mechanism could be delayed or obstructed.
Oracle Dependence and Risk
Liquidations rely on external price oracles, meaning the system inherits the risks tied to their accuracy and reliability. Should an oracle deliver delayed or incorrect data, the protocol could trigger incorrect liquidations or fail to protect lenders.
Oracle providers linked with Babylon, including Band Protocol and Pyth Network, had not commented at the time of publication.
This reliance means that while Bitcoin custody may be cryptographically enforced, broader system operations still depend on trust in off-chain data providers and network participants.
What It Aims to Solve
The white paper illustrates a typical lending scenario. For example, if someone holds 1 BTC and wants to borrow $50,000 in stablecoins on Ethereum, they must guarantee that the lender can liquidate the collateral if Bitcoin’s price falls. Under current systems, users must either trust a custodian, rely on personal promises, or wrap Bitcoin via WBTC.
WBTC, the most widely used solution, requires trust in a central custodian to safeguard the BTC reserves and honour redemptions. Babylon’s system aims to eliminate that layer of trust by enabling conditional Bitcoin transfers enforced on-chain, without intermediaries.
“Trustless vaults eliminate such assumptions,” the paper states, outlining a design where users jointly pre-sign Bitcoin transactions that define spending conditions.
