Aave Secures Initial Approval for Bitcoin-Backed Stablecoin Lending Amid Liquidation Concerns

Aave's New Borrowing Feature

On November 9, Aave's proposition allowing users to borrow stablecoins backed by Bitcoin has successfully passed its initial governance vote, according to Babylon Labs. However, this new borrowing feature is still pending final authorization before it can be utilized on the main network. The proposal garnered unanimous approval, setting the stage for the next phase, which involves drafting an Aave Improvement Proposal (AIP) for on-chain ratification.

Implementation Details

If implemented, this update will enable Bitcoin to remain secured on its native blockchain while allowing Aave to create an Ethereum-based ledger that reflects this Bitcoin collateral. It is noteworthy that borrowers will not be required to provide a freely transferable wrapped Bitcoin token.

The governance outline suggests establishing initial credit lines in stablecoins sourced from Aave's Core Hub liquidity pool. Specifically, it proposes:

• $8 million each for USDT and USDC
• $1 million for GHO
• $2 million each for USDG and RLUSD

Additionally, a separate liquidity source, dubbed the Babylon Hub, will offer liquidity providers the opportunity to hold exposure to native Bitcoin collateral, subject to distinct limits.

Risk Management and Timeline

LlamaRisk, a risk consultancy, has recommended a collateral factor of 78% for native BTC. Despite this ecosystem's innovative structure, the records for collateral will not be borrowable, ensuring that the BTC remains secured while representing backing for credits.

Babylon aims for a projected mainnet launch in late 2026, although this timeline may change based on further developments. The launch will initially be limited to certain user groups and volume constraints, and further details regarding the phased rollout are yet to be outlined. Current public information directs users to a testnet with an anticipated mainnet release in the fourth quarter.

Risks and Liquidation Processes

While the proposed setup keeps Bitcoin on its blockchain, it does not eliminate risks associated with liquidation and settlement. The Ethereum-derived collateral record will act as a restricted ERC-20 token, which means borrowers could still face losing their collateral if a liquidation event occurs.

The design plan also continues to involve Wrapped Bitcoin (WBTC). Through a system known as BTCVaultSwap, immediate liquidations can occur using WBTC borrowed from the Aave Hub, which would later be repaid by authorized traders who redeem the underlying BTC over several days as detailed in LlamaRisk's findings. The Core Hub draw cap for facilitating these settlements is proposed at 100 WBTC, separate from the immediate stablecoin lending provisions.

Permissioned participants are also capable of conducting liquidations and vault redemptions directly, owing to potential fees or borrower reimbursements that may necessitate WBTC.

Conclusion

As it stands, potential borrowers must await final AIP endorsement alongside a confirmed project timeline before transitioning from governance support to active participation in the mainnet.