Zest Protocol tests bitcoin-backed loans without moving coins off-chain

Bitcoin holds the top position among crypto assets by market capitalization, yet the vast majority of it remains unproductive. Spark's research found 91,332 BTC on Bitcoin layer-2 networks in May 2026, representing roughly 0.46% of total circulating supply. Including wrapped tokens and all Babylon staking brings that proportion to only around 0.8%.

The majority of BTC holders who put their assets to work first convert them into a wrapped form. A custodian retains the original coins while a token like WBTC represents them on Ethereum (ETH). Any loan secured by that token depends on the custodian's reliability and the integrity of its redemption system.

WBTC holders experienced that vulnerability in August 2024. BitGo announced plans to transfer WBTC custody to a joint venture with BiT Global, which is linked to Justin Sun.

At that time, Aave's Ethereum market held approximately $2.2 billion in supplied WBTC, according to risk manager Chaos Labs. Coinbase went further by delisting WBTC in December 2024. When BiT Global sued over that action, Coinbase's court filing cited the risk that control would "fall into the hands of Justin Sun."

Zest Protocol, which operates a Bitcoin lending market on Stacks, is exploring a method that keeps coins on Bitcoin. On September 23, it launched a capped mainnet demo of its Bitcoin Collateral Vaults. This allows holders to borrow against BTC on EVM chains without wrapping it.

Bitcoin is the strongest collateral asset ever created, and the least used.

Bitcoin Collateral Vaults keep BTC on Bitcoin Layer 1 while its value works elsewhere. Building the capital layer for Bitcoin.

— Zest Protocol (@ZestProtocol) September 11, 2026

How a Vault on Bitcoin Backs a Loan on EVM Chains

According to the firm, Bitcoin Collateral Vaults are self-custodial vaults operating on Bitcoin L1. Bitcoin's own protocol governs how they can be spent, and the design aims to support BitVM proof verification.

Each vault holds a single user's BTC, and coins from different users are never mixed, according to the documentation. Each vault is a Taproot output with spending paths set at deposit time, restricting where the BTC can move.

The loan takes place on an EVM chain, which in the demo is Ethereum. On that chain, the Bitcoin vault is represented by a collateral record linked exclusively to it. The borrower uses that record to draw USDC from a connected lending market while the BTC remains in the vault.

Positions can adjust after opening. Borrowers can add collateral or withdraw the excess if Bitcoin's price rises. Liquidations can also be partial, settling a predetermined amount and returning the remainder to the vault in BTC. Zest says other vault designs only allow full collateral release.

The design also accounts for a possible failure of the destination chain. If that chain went offline permanently, the depositor could still reclaim eligible BTC after a Bitcoin timelock expires. That recovery requires only the user's own key and public vault data, with no signature from Zest.

"We've spent five years on programmable Bitcoin, first on Stacks and now on Bitcoin itself. Today you can put real BTC in a vault on Bitcoin and borrow against it on mainnet," said Tycho Onnasch, founder of Zest Protocol.

Each wallet has a collateral cap until external audits are finished, after which Zest plans to move to production.

Guardians Stand Watch Until BitVM Takes Over

Bitcoin enforces the vault's spending rules, but each settlement still requires a separate verification. In the first production phase, independent guardians perform that verification, according to Zest.

When an event such as a repayment or liquidation occurs on the lending chain, an attestation triggers a settlement that the borrower authorized in advance. Guardians check that settlement, and a quorum of them can reverse an invalid payout during a contest window.

Reversed BTC returns to the vault set out in the rules. The document states that no operator can add outcomes, change amounts, or redirect payouts after the vault is established.

Zest plans to transfer that role to BitVM, a system for verifying computation on Bitcoin without altering its protocol. Under Zest's intended design, a party claiming a repayment or liquidation posts that claim on Bitcoin.

Challengers then have a set window to dispute it, forcing the claimant to submit a zero-knowledge proof. An invalid proof allows the challenger to block the withdrawal. The documentation notes that security depends on the construction Zest selects and an honest challenger acting in time.

Zest references published BitVM3 benchmarks that place onchain costs below $100. Those figures rely on the benchmarks' own assumptions, and earlier designs cost thousands.

A Rival Design Puts Zest's Guardians Under the Spotlight

Zest is among several teams aiming to keep BTC collateral on Bitcoin. Babylon Labs proposed a similar vault system for Aave V4 in May, also built on Taproot outputs. Babylon's proposal states that redemption relies on zero-knowledge proofs and challenges, with no custodian or signer group holding discretionary control over the BTC.

Zest's first production phase, on the other hand, depends on guardians until its own BitVM verification becomes operational. The company has not disclosed who the guardians are or how many form a quorum. It also has not detailed the duration of liquidation timelocks or contest windows.

Both designs face the same practical challenges. One commenter on Babylon's Aave proposal asked how liquidations would perform during market stress. The same post questioned challenger incentives and how long redemptions on Bitcoin would take. Zest's vaults will encounter those same questions once the caps are removed.

Holders who never trusted a wrapper may want the guardians named before committing more than a test amount.