Aave's Bitcoin Proposal Caps Credit but Keeps Liquidation Risk

Aave’s governance-backed proposal for native Bitcoin lending would establish initial stablecoin credit lines of $8 million each for USDT and USDC, $1 million for GHO, and $2 million each for USDG and RLUSD from Aave’s Core Hub liquidity pool, according to the proposal.

A separate Babylon Hub liquidity pool would let liquidity providers choose exposure to native Bitcoin collateral under its own limits. Risk adviser LlamaRisk recommends a “78% collateral factor for native $BTC” in its assessment. The native Bitcoin collateral record itself would remain non-borrowable: the $BTC would secure a position rather than function as the borrowed asset.

The collateral stays on Bitcoin

Keeping the underlying $BTC on Bitcoin does not remove liquidation or settlement risk. The proposal defines the Ethereum collateral record as a transfer-restricted ERC-20 accounting unit. A borrower could still lose vault collateral through liquidation even though the underlying Bitcoin never leaves its native network.

The separation leaves two operational dependencies: an Ethereum record for the position, and WBTC where a liquidation requires settlement or compensation. It does not make credit risk disappear, because liquidation can seize the borrower’s vault.

Two liquidation routes remain

Wrapped Bitcoin (WBTC) retains a role in the structure, with separate mechanics for permissionless and permissioned participants.

• Permissionless route: BTCVaultSwap would borrow WBTC from an Aave Hub to settle immediately with liquidators. Permissioned arbitrageurs would later repay that debt and redeem the underlying $BTC over several days, as LlamaRisk’s assessment describes.
• Permissioned route: Actors could liquidate and redeem vaults directly without drawing on Hub liquidity. However, fees or borrower compensation could still require WBTC.

The proposal caps Core Hub draws for that settlement venue at 100 WBTC, separately from the stablecoin lending lines. Liquidation would seize whole vaults even when clearing the debt required less than the vault’s full $BTC value. The borrower would receive discounted compensation for that remainder in wrapped $BTC.

Both routes retain a WBTC dependency, although their liquidity sources and timing differ. The permissionless route separates immediate settlement from the arbitrageurs’ later repayment and redemption of the underlying $BTC over several days.

Mainnet remains conditional

Babylon targets mainnet for late 2026, subject to change and confirmation. Its current FAQ directs users to a public testnet and gives a fourth-quarter mainnet target. Babylon says deployment will start with restrictions on participants and volume, while a schedule and staged rollout plan remain to follow.

What does this change for lenders and borrowers?

For liquidity providers, the proposal offers defined initial credit limits and a separate pool for Bitcoin-collateral exposure, with LlamaRisk recommending a 78% collateral factor. For borrowers, native Bitcoin would secure stablecoin credit while an Ethereum accounting record and a WBTC-based liquidation process determine what happens when a position is liquidated.

Until Aave confirms final AIP approval and the staged rollout schedule, the proposed $8 million USDT and $8 million USDC lines remain credit parameters rather than available borrowing capacity. Late 2026 therefore remains a conditional mainnet target, not a firm borrowing launch date.