Health Factor

The Health Factor (HF) is calculated as the ratio of the user's total collateral value (in the protocol's base currency) to their total borrowed value. The formula is typically: HF = (Total Collateral in ETH * Collateral Factor) / Total Borrowed in ETH. A value above 1.0 indicates a safe position, while a value below 1.0 triggers liquidation eligibility.

Each collateral asset has a specific liquidation threshold (e.g., 80% for ETH). This is the maximum loan-to-value (LTV) ratio at which borrowing is allowed. The Health Factor directly incorporates these thresholds. For example, if ETH's liquidation threshold is 80%, a borrowed amount exceeding 80% of the collateral's value will push the HF below 1.0, making the position eligible for liquidation by keepers.

The Health Factor is not static; it fluctuates with market prices. Key dynamics include:

• Price Oracle Updates: As the value of collateral or borrowed assets changes, the HF updates.
• Interest Accrual: Borrowing interest increases the debt side, gradually lowering the HF over time.
• User Actions: Depositing more collateral or repaying debt directly improves the Health Factor, while withdrawing collateral or borrowing more worsens it.

While the core concept is universal, implementations differ:

• Aave: Uses a single, aggregate Health Factor for a user's entire portfolio, calculated using weighted risk parameters for each asset.
• Compound: Uses a similar metric called Collateral Factor, but the liquidation check is based on individual asset collateral factors within an account.
• MakerDAO: Employs a Collateralization Ratio (CR), where positions are liquidated if the CR falls below the Liquidation Ratio for that collateral type (e.g., 150% for ETH).

The protocol's liquidation engine continuously monitors Health Factors. When HF < 1.0:

1. The position is flagged as under-collateralized.
2. Liquidators can repay a portion of the debt in exchange for seized collateral at a liquidation bonus (discount).
3. This mechanism ensures the protocol remains solvent by closing risky positions before the debt exceeds the collateral value. The exact liquidation penalty and close factor (percentage of debt that can be liquidated) are protocol parameters.

For developers building on top of lending protocols, monitoring HF via subgraphs or direct contract calls is critical for risk dashboards and alert systems. For users, understanding HF is essential for managing DeFi positions. Best practices include:

• Maintaining a HF significantly above 1.0 (e.g., >1.5) as a safety buffer against volatility.
• Monitoring asset-specific risk parameters set by governance.
• Using tools like DeFi Saver or Instadapp for automated position management.

The Health Factor (HF) is a numerical representation of a borrower's collateralization ratio, calculated as (Total Collateral Value in USD * Collateral Factor) / Total Borrowed Value in USD. A higher HF indicates a safer position. When the HF falls below 1.0 (or a protocol-specific threshold like 1.1), the position becomes eligible for liquidation.

The liquidation threshold is the HF level (e.g., 1.0) at which a position is considered undercollateralized. When triggered:

• The position becomes available for liquidators to repay part of the debt.
• In return, they receive the borrower's collateral at a liquidation discount (or penalty).
• This process protects the protocol from bad debt and ensures lenders are repaid.

A Health Factor can drop due to several market dynamics:

• Collateral Value Decline: If the price of the deposited asset falls.
• Debt Value Increase: If the price of the borrowed asset rises.
• Volatility & Oracle Risk: Rapid price swings or stale oracle data can cause unexpected liquidations.
• Protocol Parameter Changes: Updates to Collateral Factors or Liquidation Thresholds by governance can affect HF.

Borrowers actively manage HF to avoid liquidation:

• Over-collateralization: Borrowing significantly less than the maximum allowed.
• Monitoring & Alerts: Using dashboards and bots to track HF in real-time.
• Proactive Management: Adding more collateral or repaying debt before HF nears the threshold.
• Understanding Assets: Using less volatile collateral and being aware of specific asset risk parameters.

While the core concept is universal, implementations differ:

• Aave & Compound: Use a Health Factor where HF < 1 triggers liquidation.
• MakerDAO: Uses a Collateralization Ratio (CR) and a Liquidation Ratio; positions with CR below the Liquidation Ratio are liquidated.
• Liquity: Uses a Collateral Ratio and a fixed 110% minimum, with a unique Stability Pool liquidation mechanism.

In extreme market downturns, mass liquidations can create downward price pressure on collateral assets. This can trigger a positive feedback loop:

1. Falling collateral prices cause more HFs to drop below threshold.
2. Liquidations flood the market, driving prices down further.
3. This liquidation cascade can lead to market instability and impact protocol solvency, highlighting a key systemic risk in DeFi lending.

Liquidation is the automated process triggered when a borrower's Health Factor falls below 1.0. A liquidator repays part or all of the undercollateralized debt in exchange for the borrower's collateral at a discounted price. This mechanism protects the protocol from bad debt and ensures the solvency of the lending pool.

• Liquidation Threshold: The collateral value at which liquidation begins.
• Liquidation Penalty: An additional fee paid by the borrower, awarded to the liquidator.

The Loan-to-Value (LTV) ratio is the maximum borrowing power of a specific collateral asset. For example, an LTV of 75% for ETH means you can borrow up to $0.75 for every $1 of ETH deposited. The LTV is a key parameter set by the protocol governance and directly determines the initial Health Factor for a new position. A lower maximum LTV creates a higher safety margin.

The Liquidation Threshold is a protocol-defined parameter for each collateral asset, representing the percentage of its value at which a position becomes eligible for liquidation. It is distinct from the LTV. A position's Health Factor crosses below 1.0 when the borrowed value exceeds the total collateral value multiplied by the weighted average liquidation threshold of the deposited assets.

A Debt Ceiling (or borrow cap) is a protocol-level risk parameter that limits the total amount that can be borrowed against a specific collateral asset. While Health Factor manages individual position risk, debt ceilings manage systemic risk by preventing over-concentration in any single asset, which could make the entire protocol vulnerable to a price crash or oracle manipulation of that asset.