Bitcoin infrastructure company co-founder Babylon Labs says it has built a system to use native Bitcoin as trustless collateral for borrowing on the Ethereum blockchain.
In an article published on Wednesday
These comments follow Babylon’s release of a white paper in early August, outlining what it calls a trustless vault system for Bitcoin. The system leverages the BitVM3 Bitcoin smart contract verification system to lock BTC in per-user vaults, where withdrawals (redemption or liquidation) are controlled by cryptographic proofs of the state of the external smart contract verified on Bitcoin.
This allows users to lock Bitcoin and link it to Ethereum without the need for a custodian or federated bridge. On the Ethereum side, a smart contract verifies the BTC vault via a Bitcoin light client before accounting for collateral.
An experimental version of the resulting token is already available on the Morpho chain lending protocol. It is still in the testing phase, with total market liquidity of $14 USDC (USDC). Tse described VaultBTC as “a non-fungible intermediary asset that interfaces the vault with Morpho and allows depositors and liquidators to withdraw BTC with confidence. »
Babylon Labs and Tse did not respond to Cointelegraph’s request for comment by publication.
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How unreliable is that?
Although the part of the system explained previously is unreliable, some parts remain unreliable. According to the white paper, Babylon’s Bitcoin vault liquidations use whitelisted liquidators to monitor the price and condition of the vault, resulting in a liquidation system that is unauthorized and introduces trust assumptions.
Even with co-signing intended to curb censorship, the model still assumes that enough liquidators (and sometimes large lenders) behave properly. Even though they can’t steal Bitcoin due to the design of the system, this introduces an assumption of trust into the system.
Liquidations depend on a price oracle, so they inherit the accuracy, timeliness, and censorship resistance risks of the oracle. If the oracle is wrong or delayed, the system makes the wrong call. Oracle providers with existing relationships with Babylon Labs, Band Protocol and Pyth Network did not respond to Cointelegraph’s request for comment by publication.
Related: The future of DeFi is not on Ethereum, but on Bitcoin
What is really changing?
The whitepaper provides a simple example: “Bob owns 1 BTC and wants to borrow $50,000 in stablecoin from Larry via a lending protocol on Ethereum. » This would require that if the price of Bitcoin falls below $50,000, Larry can liquidate the collateral, and if Bob repays the loan on time, he gets the BTC back.
Babylon Labs explains that current systems require many trust assumptions. Bob can hand the Bitcoin to Larry for safekeeping, hoping that he will return it.
Alternatively, Bob can hold onto the Bitcoin and promise to allow Larry to liquidate it if the price drops – but Larry would trust Bob to keep his word. Finally, Bob could link Bitcoin to Ethereum as Wrapped Bitcoin (WBTC) and use it in a smart contract as collateral. However, he would have to trust the packaging mechanism itself.
WBTC requires trust because the Bitcoin that backs it is held by a centralized custodian that must be trusted not to lose, freeze, or misuse funds. Users rely on the honesty and creditworthiness of that custodian rather than cryptographic collateral. This is the main problem solved by Babylon’s trustless implementation.
“Trustless vaults eliminate all of these trust assumptions. Bob and Larry jointly pre-sign a set of Bitcoin transactions defining conditional spending rights,” the white paper states.
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