In the context of DeFi lending and margin trading protocols, free collateral represents the liquid, usable portion of a user's deposited assets. It is calculated as the total value of a user's collateral, minus the value of their outstanding borrowed assets (their debt), and further reduced by any maintenance margin or safety buffer required by the protocol. This metric is fundamental to assessing a user's financial health and capacity within a system, directly determining their ability to open new leveraged positions, borrow additional funds, or withdraw assets without risking liquidation.
LABS
Glossary
Free Collateral
Free collateral is the portion of a user's deposited collateral value that is not currently securing any debt and is available for withdrawal or to secure new loans.
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definition
DEFINITION
What is Free Collateral?
Free collateral is the amount of a user's collateral assets that remains unencumbered and available for new positions or withdrawals after accounting for all existing liabilities and margin requirements.
The calculation is a core risk management mechanism. For example, if a user deposits $10,000 in ETH as collateral and borrows $4,000 in stablecoins, their initial free collateral is $6,000. However, the protocol may enforce a collateral factor or loan-to-value (LTV) ratio of 75%, meaning only 75% of the collateral's value can be borrowed against. In this case, the borrowing power is $7,500, and the $4,000 debt leaves $3,500 of unused borrowing power, which is often synonymous with free collateral. This buffer protects the protocol from market volatility.
Monitoring free collateral is critical for users to avoid involuntary liquidation events. If the value of the deposited collateral falls or the value of the debt rises (e.g., due to asset price fluctuations), the free collateral decreases. Should it reach zero or dip below the protocol's minimum threshold, the position becomes undercollateralized, triggering an automated liquidation where some collateral is sold to repay the debt. Protocols like Aave, Compound, and MakerDAO provide real-time free collateral metrics to help users manage their positions proactively.
Beyond basic lending, the concept is central to more complex DeFi primitives. In perpetual futures exchanges, free collateral (often called available balance) determines how many new contracts can be opened. In cross-margin accounts, it is pooled across multiple positions. Advanced systems may also account for the risk-adjusted value of different collateral types, applying specific haircuts or liquidity discounts to volatile assets, which further refines the true amount of free, risk-free capital available to the user.
key-features
FREE COLLATERAL
Key Features
Free Collateral is the portion of a user's posted collateral that is not actively securing any loans or positions, representing immediately available capital for new financial actions.
01
Capital Efficiency
Free Collateral is a core metric for capital efficiency in DeFi. It allows users to maximize the utility of a single asset deposit by enabling it to back multiple positions or loans simultaneously without requiring additional funds. This reduces idle capital and increases potential returns on a given portfolio.
02
Risk Buffer & Safety
This unencumbered value acts as a risk buffer. It provides a margin of safety against market volatility, as price drops in collateralized assets will first consume free collateral before triggering a liquidation. Protocols often set minimum free collateral ratios to maintain system solvency.
03
Dynamic Calculation
Free Collateral is calculated dynamically as: Total Collateral Value - Total Borrowed Value. It fluctuates with:
- Asset Price Changes: Affects the value of posted collateral.
- Debt Accrual: Interest on loans reduces free collateral over time.
- New Positions: Opening loans or minting synthetic assets locks collateral, reducing the free amount.
04
Use Cases & Actions
Users can deploy Free Collateral for various on-chain actions without adding new funds, including:
- Taking out additional loans from money markets like Aave or Compound.
- Minting synthetic assets or stablecoins (e.g., minting DAI against ETH).
- Providing liquidity in automated market makers (AMMs).
- Opening new leveraged positions on perpetual futures exchanges.
05
Protocol-Specific Implementation
While the core concept is universal, calculation methods vary. For example:
- Aave: Uses a Health Factor, where Free Collateral is implied by the buffer before the factor drops below 1.
- Compound: Similar to Aave, governed by a Collateral Factor.
- MakerDAO: Uses a Collateralization Ratio (CR); Free Collateral is the margin above the minimum CR required for a Vault.
- Synthetix: Stakers have unlocked SNX that can be used as free collateral for minting sUSD.
06
Related Concepts
Understanding Free Collateral requires familiarity with:
- Collateralization Ratio: The ratio of collateral value to debt value.
- Health Factor / Liquidation Threshold: The risk metric that triggers liquidation when breached.
- Overcollateralization: The practice of posting more collateral than the loan value, which inherently creates Free Collateral.
- Cross-margining: Using a single pool of collateral (and its free portion) to margin multiple positions across a protocol.
how-it-works
DEFINITION
How Free Collateral Works
Free collateral is the portion of a user's posted collateral that is not actively backing any open positions or loans, representing the capital available for new transactions.
Free collateral is a core metric in decentralized finance (DeFi) protocols that determines a user's capacity to engage in new financial activities. It is calculated by subtracting the used collateral—the value locked to secure existing positions like loans or derivatives—from the user's total collateral deposited into the protocol. This remaining, unencumbered value represents the liquidity a user can immediately deploy to open new leveraged positions, mint additional stablecoins, or provide liquidity without needing to deposit more assets. It is the foundational measure of borrowing power and financial flexibility within a protocol's ecosystem.
The calculation is intrinsically linked to a protocol's collateral factor or loan-to-value (LTV) ratio. For example, if a user deposits $10,000 of ETH with a 75% LTV, their initial borrowing power is $7,500. If they borrow $3,000 of a stablecoin, their used collateral becomes $3,000 / 0.75 = $4,000. Their free collateral is then $10,000 (total) - $4,000 (used) = $6,000. This $6,000 can support new borrowing up to $4,500 (75% of $6,000). This mechanism ensures that all open positions remain sufficiently overcollateralized to protect the protocol from insolvency due to market volatility.
Free collateral is a dynamic value that fluctuates with market prices. As the value of the underlying collateral assets rises or falls, so does the total collateral value, directly impacting the free amount. Protocols continuously monitor these ratios through oracles. If market depreciation causes the used collateral to approach or exceed the total (i.e., free collateral nears zero or becomes negative), the protocol may issue a liquidation warning or automatically trigger a liquidation event to repay the undercollateralized debt. Therefore, users must actively manage their free collateral to maintain a safety buffer against price swings and avoid forced liquidations.
Understanding free collateral is essential for effective risk management in DeFi. It is the key lever for capital efficiency, allowing users to recycle and rehypothecate their assets across multiple protocols. However, it also concentrates risk; high utilization of borrowing power leaves little margin for error during market downturns. Advanced users often employ strategies like collateral swapping (exchanging depreciating assets for stable ones) or using debt refinancing across platforms to optimize their free collateral position, maximizing leverage while attempting to mitigate liquidation risks inherent in volatile crypto markets.
calculation-formula
FREE COLLATERAL
The Calculation Formula
A detailed breakdown of the mathematical formula used to determine a user's available collateral for new positions or withdrawals in a DeFi protocol.
The Free Collateral formula calculates the amount of collateral a user can withdraw or use to open new positions without triggering liquidation. It is the difference between a user's Total Collateral Value and their Total Initial Margin Requirement. The core formula is expressed as: Free Collateral = Total Collateral Value - Total Initial Margin Requirement. This value is dynamic, updating in real-time with market price fluctuations and changes to a user's open positions.
To compute this, the protocol first aggregates the value of all deposited assets, applying specific collateral factors (or Loan-to-Value ratios) to determine the Borrowing Power of each asset. The Total Initial Margin Requirement is the sum of the initial margin needed for all active positions, such as loans or perpetual futures. A positive Free Collateral balance indicates a healthy, under-leveraged account, while a negative or zero balance risks immediate liquidation.
This calculation is foundational for risk management in lending protocols like Aave and Compound, and decentralized exchanges like dYdX and GMX. It ensures the system remains over-collateralized. Key inputs include oracle prices for assets, protocol-specific collateral factors, and the maintenance margin requirements for derivatives. Understanding each component—collateral value, haircuts, and margin—is essential for users to manage their leverage and avoid unexpected liquidations.
ecosystem-usage
IMPLEMENTATIONS
Protocol Examples
Free collateral is a foundational concept in DeFi lending, but its specific mechanics and terminology vary by protocol. These examples illustrate how major platforms manage and calculate this critical buffer.
02
Compound: Collateral Factor
Compound defines a Collateral Factor for each asset, representing the maximum percentage of its value that can be borrowed against. A user's Borrowing Power is the sum of (Collateral Balance * Collateral Factor) across all supplied assets. Free Collateral is the unused portion of this borrowing power. The protocol prevents borrowing if it would cause the account's Account Liquidity to fall below zero, which is the real-time calculation of this available buffer.
03
MakerDAO: Collateralization Ratio & Dai Debt
In Maker's Vault system (e.g., for ETH-A), users must maintain a Collateralization Ratio (CR) above a Liquidation Ratio. Free Collateral is the amount of extra collateral value that can be removed or the amount of additional Dai debt that can be generated before hitting the liquidation point. It's calculated as: (Collateral Value - (Dai Debt * Liquidation Ratio)). The Stability Fee accrues on the debt, dynamically reducing free collateral over time.
04
dYdX & Perpetuals: Maintenance Margin
On perpetual futures exchanges like dYdX, Free Collateral is the capital available to open new positions or absorb mark-to-market losses. It is calculated as Total Collateral - Initial Margin - Unrealized PNL. The critical threshold is the Maintenance Margin Requirement. If the account's equity (collateral + PNL) falls below this level, it faces liquidation. This model emphasizes real-time risk management for leveraged trading.
05
Liquity: Minimum Collateral Ratio & Recovery Mode
Liquity requires a Minimum Collateral Ratio (MCR) of 110% for its stablecoin, LUSD. A user's Trove has free collateral when its ratio is above the MCR. The protocol has a unique Recovery Mode that activates if the system's total collateral ratio falls below 150%. In this mode, the MCR effectively increases, and Troves below 150% can be liquidated, dynamically redefining what constitutes 'free' and 'at-risk' collateral.
06
Generalized Lending (Euler, Solend)
Modern risk-managed lending protocols like Euler Finance abstract free collateral through risk-adjusted values. They use Collateral Factors and Borrow Factors to compute a Risk-Adjusted Liability Value. Free Collateral is the surplus of Risk-Adjusted Collateral Value over this liability. This allows for more granular, asset-specific risk controls (e.g., volatile assets have lower collateral factors) and isolation of risky asset debt from safer collateral pools.
strategic-uses
CAPITAL EFFICIENCY
Strategic Uses of Free Collateral
Free collateral is not idle capital. It represents unlocked capital efficiency, enabling a range of advanced financial strategies within DeFi protocols.
01
Recursive Leverage
Using free collateral to borrow more of the same asset, creating a leveraged long position. This is a core mechanism in lending protocols like Aave and Compound.
- Process: Deposit ETH as collateral → borrow stablecoins → swap for more ETH → deposit again.
- Risk: Increases exposure to liquidation risk if the asset price declines.
02
Yield Farming & Liquidity Provision
Deploying free collateral into liquidity pools on DEXs (e.g., Uniswap, Curve) to earn trading fees and liquidity provider (LP) tokens. These LP tokens can often be used as collateral elsewhere, creating a collateral flywheel.
- Example: Use free USDC to provide liquidity in a USDC/DAI pool, earn fees, and stake the LP token for additional yield.
03
Cross-Protocol Strategies
Free collateral enables capital to move fluidly between protocols to maximize returns. This is the basis of DeFi money legos.
- Common Flow: Use collateral in a lending protocol to borrow an asset → supply that asset to a yield aggregator like Yearn → use the yield-bearing token as collateral in another protocol.
- Goal: Optimize for the highest risk-adjusted yield across the ecosystem.
04
Hedging & Risk Management
Free collateral can be used to open positions that offset risk from a primary investment.
- Perpetual Futures: Post free collateral as margin to open short positions on DEXs like dYdX or GMX to hedge a long spot holding.
- Options Protocols: Use collateral to sell covered call options on platforms like Lyra or Dopex, generating premium income against an asset position.
05
Collateral for Gas & Protocol Fees
In some ecosystems, free collateral can be staked to pay for network operations, reducing the need to hold native tokens for gas.
- Example: On Ethereum L2s like Arbitrum, staking ETH as collateral can cover transaction fees, abstracting gas for users.
- Benefit: Improves user experience and capital efficiency by utilizing a single asset for multiple purposes.
06
Undercollateralized Lending
Advanced protocols use free collateral as a component in credit delegation or under-collateralized loan models. A user's proven collateral position in one protocol (their creditworthiness) can be used to secure a loan with less than 100% collateralization elsewhere.
- Mechanism: Protocols like Aave allow users to delegate their borrowing power from supplied collateral to a trusted borrower.
security-considerations
FREE COLLATERAL
Risks and Considerations
Free collateral represents the unencumbered, withdrawable value in a lending position. While it provides flexibility, it introduces specific risks that must be managed.
01
Liquidation Risk
Free collateral is not a buffer against liquidation. If the value of your borrowed assets increases or your supplied collateral value decreases, your position can be liquidated even if you have free collateral. This is because liquidation is triggered by the health factor or collateral ratio, which is calculated using only the locked collateral securing the loan.
02
Withdrawal & Slippage
Withdrawing free collateral, especially in large amounts or from less liquid pools, can incur slippage and price impact. This reduces the actual value you receive. On automated market maker (AMM)-based protocols, a large withdrawal can move the pool's price, creating an effective loss versus the expected amount.
03
Protocol-Specific Rules
Not all free collateral is immediately usable. Protocols impose rules such as:
- Withdrawal caps or timelocks.
- Requirements to maintain a minimum health factor after withdrawal.
- Different calculations for "withdrawable" vs. "borrowable" collateral (e.g., some assets may be borrowable but not withdrawable). Always check the specific protocol's documentation.
04
Oracle Risk & Valuation
The amount of free collateral is calculated using oracle prices. If an oracle provides a stale or manipulated price, the displayed free collateral will be inaccurate. Withdrawing based on this faulty data can immediately put your position at risk of undercollateralization upon price correction.
05
Interest Accrual Impact
Free collateral does not earn yield in most lending protocols. More critically, your debt continues to accrue interest even if you have free collateral. Over time, this growing debt reduces your health factor, increasing liquidation risk unless you actively manage the position.
06
Cross-Protocol Contagion
Free collateral is often used in DeFi composability (e.g., supplying it to another protocol as collateral for a new position). This creates interconnected risk. A failure, exploit, or sudden parameter change (like a collateral factor reduction) in the secondary protocol can jeopardize the primary position.
DEFINITIONAL COMPARISON
Free Collateral vs. Related Terms
A comparison of Free Collateral with other key collateral metrics used in DeFi lending and borrowing protocols.
| Metric / Feature | Free Collateral | Total Collateral | Collateral Factor | Health Factor |
|---|---|---|---|---|
Primary Definition | The portion of a user's collateral that is not backing existing loans and is available to borrow against or withdraw. | The total value of all assets deposited by a user into a lending protocol as security. | The maximum loan-to-value (LTV) ratio allowed for a specific collateral asset, expressed as a percentage. | A numerical value representing the safety of a loan position; a value below 1.0 risks liquidation. |
Purpose | To quantify available borrowing power or withdrawable assets. | To calculate the base value securing a user's debt positions. | To set risk parameters and limit borrowing power per asset. | To monitor position risk and trigger liquidations. |
Calculation | Total Collateral Value - (Total Borrowed Value / Collateral Factor) | Sum(Asset Amount * Asset Price) | Set by protocol governance (e.g., 75% for ETH). | Total Collateral Value * Collateral Factor / Total Borrowed Value |
Dynamic Change | Changes with asset prices, debt levels, and new deposits/withdrawals. | Changes with asset prices and new deposits/withdrawals. | Generally static, changed via governance updates. | Changes continuously with market prices of collateral and debt. |
Direct User Action | Determines if a user can borrow more or withdraw assets. | Viewed as account summary; necessary for other calculations. | Viewed as a protocol rule; determines borrowing limit. | Monitored to avoid liquidation; may prompt adding collateral or repaying debt. |
Relation to Liquidation | If zero or negative, no new borrowing or withdrawals are allowed, but existing position may still be safe. | A component in the liquidation threshold calculation. | Inversely defines the liquidation threshold (e.g., 75% CF = ~83% liquidation threshold). | Primary liquidation trigger; falling below 1.0 initiates the liquidation process. |
Typical Representation | A currency value (e.g., $5,000 USD). | A currency value (e.g., $20,000 USD). | A percentage (e.g., 75%). | A numeric ratio (e.g., 1.85). |
FREE COLLATERAL
Common Misconceptions
In DeFi lending, 'free collateral' is a frequently misunderstood concept that can lead to unexpected liquidations. This section clarifies the mechanics and risks.
Free collateral is the portion of a user's deposited assets in a lending protocol that is not currently securing an active loan, representing the remaining borrowing capacity. It is calculated by subtracting the total borrowed value (plus accrued interest) from the total collateral value, after applying the appropriate loan-to-value (LTV) ratio. For example, if you deposit $10,000 of ETH (with a 75% LTV) and borrow $5,000, your free collateral is $2,500 ($10,000 * 0.75 - $5,000). This $2,500 represents the maximum additional amount you can borrow against your existing deposit without adding more collateral. It is a dynamic figure that fluctuates with both the market price of your collateral assets and the accrual of interest on your debt.
FREE COLLATERAL
Frequently Asked Questions
Free collateral is a core concept in DeFi lending and borrowing, representing the liquid capital available for further financial actions. These questions address its calculation, importance, and practical implications.
Free collateral is the portion of a user's deposited assets in a lending protocol that is not currently backing any active loan, representing the liquid, unencumbered value available for new borrowing or withdrawal. It is calculated by subtracting the total borrowed value (plus any accrued interest) from the user's total supplied collateral value, after applying the protocol's specific loan-to-value (LTV) ratios. For example, if you deposit $10,000 of ETH (with a 75% LTV) and borrow $3,000 of USDC, your free collateral is not simply $7,000. The borrowing power of your ETH is $7,500 (75% of $10,000). Since you've used $3,000, you have $4,500 of remaining borrowing power, which is your free collateral. This metric is crucial for managing positions and avoiding liquidation.
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