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      Babylon Labs Proposes Bitcoin Collateral System for Aave V4

      Babylon Labs is advancing a proposal to enable users to borrow against Bitcoin (BTC) on the Aave V4 platform without transferring their assets off the Bitcoin network. This initiative aims to allow BTC holders to maintain custody of their coins while accessing liquidity through decentralized finance (DeFi). The plan hinges on Babylon's Trustless Bitcoin Vaults protocol, which utilizes self-custodial Taproot UTXOs to secure the BTC, ensuring that no third party holds the keys to the assets.

      Under this proposal, borrowers would use their vault-backed BTC to obtain assets like USDC, USDT, and WBTC. Liquidations, a critical aspect of lending markets, would be handled through a mechanism that pays liquidators in WBTC, allowing for immediate settlement while keeping the collateral on the Bitcoin network. This design aims to streamline the liquidation process and maintain permissionless access for liquidators, enhancing the efficiency of the lending market.

      The partnership between Babylon and Aave was first announced in December 2025, with a formal governance process beginning in May 2026. A public testnet for the native BTC-backed borrowing feature was launched in October 2026, coinciding with HashKey Cloud's integration of the Trustless Bitcoin Vaults for institutional clients. This development is particularly significant for custody-conscious investors who have historically been wary of wrapped Bitcoin solutions.

      The success of this initiative could reshape the relationship between Bitcoin and DeFi, allowing long-term holders to participate in lending markets without relinquishing custody of their assets. However, the proposal still requires further governance votes and the establishment of risk parameters before it can be fully implemented on the mainnet.

      © 2026 KLEA News. All Rights Reserved. This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.

      Source: KLEA News

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