Babylon Labs Builds VaultBTC System for Trustless Bitcoin Lending on Ethereum

• The VaultBTC prototype shows $14 liquidity while removing centralized custodians.
• System use depends on semi-trusted liquidators and external oracles.

On October 16, 2025, Cointelegraph reported that Babylon Labs announced a proof-of-concept for a new system allowing native Bitcoin to be used as trustless collateral for lending on the Ethereum blockchain. The system, presented by Babylon Labs co-founder and Stanford University professor David Tse, leverages BitVM3 technology to eliminate reliance on centralized custodians or wrapped representations like WBTC.

The proposed system uses a "Bitcoin trustless vault," which locks users' Bitcoin. Any withdrawal for redemption or liquidation depends on cryptographic proofs of external smart contract states, which are then verified on the Bitcoin blockchain. Simultaneously, a smart contract on Ethereum validates these proofs through a Bitcoin light client before recognizing the collateral.

An experimental version, named VaultBTC, is currently being tested on the decentralized lending protocol Morpho. However, it is still in a highly experimental phase with minimal market engagement. According to Cointelegraph, the system's liquidity remains extremely low, with total assets amounting to just $14 in USDC. Tse characterized VaultBTC as an "intermediate non-fungible asset," enabling depositors and liquidators to execute withdrawals trustlessly on the platform.

Despite its claim of being "trustless," the system introduces semi-trusted elements. According to Babylon Labs' white paper, the liquidation process depends on whitelisted liquidators to monitor asset prices and vault states. These liquidators play a critical role in system reliability. While they cannot steal Bitcoin directly, the system's functionality depends on their actions being both timely and accurate.

The trustless mechanism is further reliant on external price oracles for liquidation accuracy. Delays or inaccuracies in these oracles could result in improper liquidations, affecting user assets. This highlights the need for an accurate and timely flow of data to maintain the system's integrity.

Babylon Labs' solution addresses the long-standing issue of trust in existing Bitcoin-based DeFi systems. Traditionally, users had to rely on third-party custodians for wrapped Bitcoin or trust counterparties in loan agreements. With this new system, predefined Bitcoin transactions are signed conditionally to enforce agreements, aiming to provide an alternative to custodial methods while promoting cross-chain asset usage. However, its real value will depend on further testing and the resolution of challenges related to its semi-trust-based components.

As of October 16, 2025, 15:10 UTC, Bitcoin (BTC) is trading at $110,448.17, with a 0.79% decline in 24-hour trading volume, according to the latest market data. Meanwhile, Ethereum (ETH) is priced at $4,006.43, reflecting a 0.35% decrease in 24-hour trading volume as of 15:11 UTC.