A co-founder of Bitcoin infrastructure company Babylon Labs claims to have developed a system that permits native Bitcoins for use as trusted collateral for loans on the Ethereum blockchain.
David Tse, co-founder of Babylon Labs and a professor at Stanford University, claimed in a post on Wednesday
The comments follow Babylon's publication of a white paper in early August detailing the so-called trustless Bitcoin vault system. The system uses the Bitcoin smart contract verification system BitVM3 to lock BTC in custom vaults, where withdrawals (redemption or liquidation) are controlled by cryptographic proof of the external smart contract status verified on Bitcoin.
This allows users to lock Bitcoin and connect it to Ethereum without counting on a federated custodian or bridge. On the Ethereum side, a sensible contract verifies the BTC vault via a Bitcoin light client before considering collateral.
An experimental version of the resulting token is already available on the on-chain lending protocol Morpho. However, it remains to be within the testing phase and the whole liquidity available in the market is $14 in USDC (USDC). Tse described VaultBTC as “a non-fungible intermediate asset that connects the vault to Morpho and allows depositors and liquidators to withdraw BTC without trust.”
A schematic of the Bitcoin Vault based credit system. Source: Babylon Labs
Babylon Labs and Tse didn’t reply to Cointelegraph's request for comment via publication.
How trustworthy is it?
While the a part of the system explained earlier is trustworthy, some parts remain untrustworthy. According to the white paper, Babylon's Bitcoin vault liquidations employ whitelisted liquidators to watch price and vault status, leading to a liquidation system that’s permissionless and introduces trust assumptions.
Even though co-signing is meant to curb censorship, the model still assumes that enough liquidators (and sometimes large lenders) behave appropriately. Even if they can not steal Bitcoins resulting from the system design, this creates an assumption of trust within the system.
Liquidations depend upon a price oracle and subsequently inherit the oracle's accuracy, timeliness and censorship resistance risks. If the oracle is improper or delayed, the system makes the improper call. Oracle providers with existing relationships with Babylon Labs, Band Protocol and Pyth Network didn’t reply to Cointelegraph's request for comment via publication.
What really changes?
The white paper provides an easy example: “Bob owns 1 BTC and desires to borrow $50,000 in a stablecoin from Larry using a lending protocol on Ethereum.” This would require Larry to have the option to liquidate the collateral if the Bitcoin price falls below $50,000, and if Bob repays the loan on time, he’ll receive the BTC back.
Babylon Labs explains that current systems require quite a few trust assumptions. Bob may give the Bitcoin to Larry for safekeeping and trust him to return it.
Otherwise, Bob can keep the Bitcoin and promise Larry that he’ll liquidate it if the worth falls – but Larry would trust Bob to maintain his word. Finally, Bob could connect Bitcoin to Ethereum as Wrapped Bitcoin (WBTC) and use it as collateral in a sensible contract. Still, he needed to trust the winding mechanism itself.
WBTC requires trust since the Bitcoins behind it are held by a central custodian that could be trusted to not lose, freeze or misuse the funds. Users depend on the honesty and solvency of this custodian slightly than cryptographic guarantees. This is the essential problem addressed by Babylon's trustless implementation.
“Trustless vaults eliminate all such trust assumptions. Bob and Larry jointly pre-sign a series of Bitcoin transactions that outline conditional issuance rights,” the white paper states.
