diff --git a/src/shared/config.ts b/src/shared/config.ts
index 7073f58..2e72bae 100644
--- a/src/shared/config.ts
+++ b/src/shared/config.ts
@@ -144,9 +144,7 @@ export async function getMcpConfigForManifest(
   // First, add defaults from manifest
   if (manifest.user_config) {
     for (const [key, configOption] of Object.entries(manifest.user_config)) {
-      if (configOption.default !== undefined) {
-        mergedConfig[key] = configOption.default;
-      }
+      mergedConfig[key] = configOption.default ?? "";
     }
   }
 
@@ -159,16 +157,17 @@ export async function getMcpConfigForManifest(
   for (const [key, value] of Object.entries(mergedConfig)) {
     // Convert user config to the format expected by variable substitution
     const userConfigKey = `user_config.${key}`;
+    const substitutedValue = replaceVariables(value ?? "", variables);
 
-    if (Array.isArray(value)) {
+    if (Array.isArray(substitutedValue)) {
       // Keep arrays as arrays for proper expansion
-      variables[userConfigKey] = value.map(String);
-    } else if (typeof value === "boolean") {
+      variables[userConfigKey] = substitutedValue.map(String);
+    } else if (typeof substitutedValue === "boolean") {
       // Convert booleans to "true"/"false" strings as per spec
-      variables[userConfigKey] = value ? "true" : "false";
+      variables[userConfigKey] = substitutedValue ? "true" : "false";
     } else {
       // Convert other types to strings
-      variables[userConfigKey] = String(value);
+      variables[userConfigKey] = String(substitutedValue);
     }
   }
 
diff --git a/test/config.test.ts b/test/config.test.ts
index 7e29f69..a39304a 100644
--- a/test/config.test.ts
+++ b/test/config.test.ts
@@ -349,6 +349,73 @@ describe("getMcpConfigForManifest", () => {
 
     expect(result?.args).toEqual(["server.js", "--verbose=true"]);
   });
+
+  it("should replace system variables inside user config defaults", async () => {
+    const manifest: McpbManifestAny = {
+      ...baseManifest,
+      user_config: {
+        server_path: {
+          type: "file",
+          title: "Server Path",
+          description: "Path to the server binary",
+          default: "${HOME}/bin/server",
+        },
+      },
+      server: {
+        type: "binary",
+        entry_point: "${user_config.server_path}",
+        mcp_config: {
+          command: "${user_config.server_path}",
+        },
+      },
+    };
+
+    const result = await getMcpConfigForManifest({
+      manifest,
+      extensionPath: "/ext/path",
+      systemDirs: { ...mockSystemDirs, HOME: "/home/user" },
+      userConfig: {},
+      pathSeparator: "/",
+      logger: mockLogger,
+    });
+
+    expect(result?.command).toBe("/home/user/bin/server");
+  });
+
+  it("should substitute missing optional user config values with empty strings", async () => {
+    const manifest: McpbManifestAny = {
+      ...baseManifest,
+      user_config: {
+        azure_tenant_id: {
+          type: "string",
+          title: "Entra Tenant ID",
+          description: "Optional tenant id",
+        },
+      },
+      server: {
+        type: "node",
+        entry_point: "server.js",
+        mcp_config: {
+          command: "node",
+          args: ["server.js"],
+          env: {
+            AZURE_TENANT_ID: "${user_config.azure_tenant_id}",
+          },
+        },
+      },
+    };
+
+    const result = await getMcpConfigForManifest({
+      manifest,
+      extensionPath: "/ext/path",
+      systemDirs: mockSystemDirs,
+      userConfig: {},
+      pathSeparator: "/",
+      logger: mockLogger,
+    });
+
+    expect(result?.env?.AZURE_TENANT_ID).toBe("");
+  });
 });
 
 describe("hasRequiredConfigMissing", () => {