Aave Bitcoin lending plan clears preliminary vote, but liquidation risks remain

Babylon Labs said Aave's proposal for stablecoin borrowing against native Bitcoin passed the preliminary ARFC governance vote on Nov. 9. Babylon reported that the proposal received 100% support. The plan would integrate Babylon's Trustless Bitcoin Vaults with Aave V4. An Aave Improvement Proposal (AIP) seeking final on-chain approval is the next governance step, and mainnet borrowing remains unavailable pending approval.

The proposed arrangement would keep the underlying BTC locked on Bitcoin. An accounting record on Ethereum would allow Aave to recognize the BTC as collateral. Borrowers would not have to provide a wrapped Bitcoin token that can be freely transferred. The collateral record would represent BTC backing a position and would not itself be available to borrow. Risk adviser LlamaRisk recommends setting the collateral factor for native BTC at 78%.

The governance proposal specifies initial stablecoin credit lines from Aave's Core Hub liquidity pool. The proposed USDT and USDC credit lines would each total $8 million. GHO would have a $1 million credit line. USDG and RLUSD would each have a $2 million credit line. A separate pool called the Babylon Hub would allow liquidity providers to select exposure to native Bitcoin collateral under separate limits.

Babylon targets a late-2026 mainnet launch, although the target remains subject to confirmation and change. Babylon says the initial deployment will limit participation and volume. Babylon has yet to provide a schedule and a staged deployment plan. Babylon's current FAQ points users toward a public testnet and identifies the fourth quarter as the mainnet target.

Holding the underlying BTC on Bitcoin would not eliminate liquidation or settlement risks. The Ethereum collateral record would take the form of an ERC-20 accounting unit with transfer restrictions. Liquidation could still cause borrowers to lose the collateral held in vaults.

Wrapped Bitcoin (WBTC) would retain a settlement role under the proposal. The permissionless liquidation process would use BTCVaultSwap to obtain WBTC loans from an Aave Hub for immediate settlement with liquidators. LlamaRisk's assessment describes permissioned arbitrageurs subsequently repaying the WBTC debt and redeeming the underlying BTC over several days. The proposed Core Hub draw cap for this settlement mechanism is 100 WBTC, distinct from the stablecoin credit lines.

Permissioned actors could also liquidate vaults and redeem the underlying BTC directly without using Hub liquidity. However, fees or compensation for borrowers could still require WBTC. Liquidation would take an entire vault even if the debt were smaller than the vault's full BTC value. The borrower would receive wrapped BTC as discounted compensation for the remaining value. Prospective borrowers still need final AIP approval and confirmation of the deployment schedule before gaining mainnet access.