Risk Parameters

The maximum borrowing power against a collateral asset, expressed as a percentage. An LTV of 75% means a user can borrow up to $75 against $100 of deposited collateral. This is the primary buffer against price volatility.

• Key Function: Determines initial borrowing limit.
• Risk Relationship: A lower LTV provides a larger safety cushion.
• Example: Ethereum might have an 80% LTV, while a more volatile asset might be set at 50%.

The collateral value ratio at which a position becomes eligible for liquidation. This is distinct from the LTV and is always higher. If a user's debt exceeds this threshold, liquidators can repay part of the debt to seize collateral at a discount.

• Key Function: Triggers the liquidation process.
• Critical Detail: Must be set above the LTV to create a liquidation buffer.
• Example: With an 80% LTV, the liquidation threshold might be 85%.

The incentive paid to liquidators for closing an unhealthy position. It is a percentage added to the repaid debt amount, allowing the liquidator to seize more collateral than the value of debt repaid. This ensures the protocol remains over-collateralized.

• Key Function: Incentivizes swift liquidation to protect the protocol.
• Mechanism: Often ranges from 5% to 15%.
• Example: A 10% penalty on a $100 debt repayment lets the liquidator claim $110 worth of collateral.

A real-time metric representing the safety of a user's position. It is calculated as (Collateral Value * Liquidation Threshold) / Borrowed Value. A Health Factor below 1.0 indicates the position is under-collateralized and subject to liquidation.

• Key Function: Dynamic, user-facing indicator of risk.
• Monitoring: Users must maintain a Health Factor > 1.0.
• Core Formula: HF = (Σ Collateral * Threshold) / Σ Borrows.

Protocol-level limits on the total amount that can be borrowed against a specific collateral type or by a single borrower. These are systemic risk controls to prevent over-concentration and limit exposure to any single asset or entity.

• Key Function: Manages protocol-wide exposure and diversification.
• Types: Global Debt Ceiling (per asset), Borrow Cap (per user).
• Purpose: Mitigates tail risk and oracle manipulation attacks.

The source and configuration for asset price data, which is fundamental to all other parameter calculations. Risk parameters are meaningless without accurate, timely, and manipulation-resistant price feeds.

• Key Function: Provides the valuation basis for collateral and debt.
• Considerations: Decentralization, update frequency (heartbeat), and fallback mechanisms.
• Risk: Oracle failure or latency is a primary attack vector.

The Loan-to-Value (LTV) ratio is the maximum amount a user can borrow against a specific collateral asset, expressed as a percentage. For example, an LTV of 75% on $100 of ETH collateral allows a maximum $75 loan. This is the primary defense against undercollateralization.

• Purpose: Limits borrowing to maintain a collateral buffer.
• Risk: A lower LTV is safer for volatile assets.
• Example: Aave uses dynamic LTVs, where ETH might have an 80% LTV while a more volatile asset might be set at 50%.

The Liquidation Threshold is the LTV ratio at which a borrower's position becomes eligible for liquidation. It is always set higher than the maximum LTV to create a safety cushion.

• Mechanism: If (Borrowed Value / Collateral Value) > Liquidation Threshold, the position can be liquidated.
• Buffer: The gap between the LTV and the Liquidation Threshold is the "safety margin."
• Example: With an 80% LTV and an 85% Liquidation Threshold, a position is liquidatable when the collateral value drops such that the debt represents more than 85% of its worth.

The Health Factor (HF) is a real-time, user-specific metric that indicates the safety of a borrowing position. It is calculated as (Total Collateral Value * Liquidation Threshold) / Total Borrowed Value.

• HF > 1: Position is safe.
• HF ≤ 1: Position is undercollateralized and subject to liquidation.
• Monitoring: Users must monitor their HF to avoid liquidation, especially during market volatility.

The Liquidation Penalty (paid by the borrower) or Liquidation Bonus (earned by the liquidator) is an incentive mechanism to ensure timely liquidation of unhealthy positions.

• Function: Compensates liquidators for their work and risk, while penalizing borrowers for poor risk management.
• Typical Range: Often between 5% and 15% of the liquidated amount.
• Process: A liquidator repays part of the debt in exchange for the collateral at a discounted price (the bonus).

The Reserve Factor is a percentage of the interest paid by borrowers that is diverted to a protocol's treasury or reserve fund, rather than being distributed to depositors.

• Purpose: Creates a revenue stream for protocol development, insurance funds, and covering bad debt.
• Impact: A higher reserve factor means slightly lower yield for depositors.
• Governance: Typically set and adjusted via decentralized governance votes.

The Utilization Rate (U) measures the proportion of total supplied assets that are currently borrowed. It's calculated as Total Borrows / Total Liquidity.

• Critical Metric: Directly influences interest rates via rate models.
• High Utilization (>80%): Indicates high demand, leading to sharply rising borrow rates to incentivize repayments or more deposits.
• Low Utilization: Suggests ample liquidity, typically resulting in lower, stable rates.

The Loan-to-Value (LTV) ratio is the maximum amount that can be borrowed against a specific collateral asset, expressed as a percentage. It is the primary guard against undercollateralization.

• Example: An asset with a 75% LTV allows a user to borrow up to $75 for every $100 of collateral deposited.
• A lower LTV indicates a more conservative, safer risk assessment for that asset.

The liquidation threshold is the LTV ratio at which a position becomes undercollateralized and eligible for liquidation. It is always set higher than the maximum borrow LTV to create a safety buffer.

• Mechanism: If a user's health factor falls below 1.0 (i.e., debt value exceeds the liquidation threshold value of collateral), liquidators can repay part of the debt in exchange for seized collateral at a discount.

The liquidation penalty (for borrowers) or liquidation bonus (for liquidators) is an incentive mechanism to ensure timely liquidation of unhealthy positions.

• It is a percentage added to the debt repaid by the liquidator, who receives collateral worth more than the repaid amount.
• This penalty protects the protocol from bad debt but must be balanced to avoid excessive user losses or insufficient liquidator incentives.

Debt ceilings (or borrowing caps) are protocol-level limits on the total amount that can be borrowed against a specific collateral type or by a specific asset.

• Purpose: They mitigate concentration risk and systemic risk by preventing overexposure to a single asset that may become volatile or illiquid.
• Example: A stablecoin may have a global debt ceiling of $500M across the entire protocol to limit its impact in a depeg scenario.

Risk parameters depend entirely on accurate and secure oracle price feeds. Oracle configuration is a critical risk parameter itself.

• Key settings include: The oracle source (e.g., Chainlink), price feed heartbeat (update frequency), and deviation thresholds for triggering updates.
• Incorrect or stale prices can cause faulty liquidations or allow undercollateralized positions to go undetected.

The health factor is a real-time, user-position metric derived from risk parameters (LTV, liquidation threshold). It quantifies the safety of a borrowing position.

• Formula: Health Factor = (Collateral Value * Liquidation Threshold) / Borrowed Value
• Interpretation: A health factor above 1.0 is safe. As it approaches 1.0 from above, the risk of liquidation increases. It is the single most important user-facing risk indicator.