Health Factor

The Health Factor (HF) is a numerical value, typically expressed as a ratio like 1.5 or 2.0, that represents the risk level of a user's collateralized debt position (CDP) in a lending protocol such as Aave or Compound. It is calculated by dividing the total collateral value (in a base currency like USD) by the total borrowed value, adjusted for each asset's liquidation threshold. A higher Health Factor indicates a safer, less risky position, as the collateral value significantly exceeds the borrowed amount. Conversely, a lower Health Factor signals increased risk of liquidation.

The core mechanism works by assigning each type of collateral asset a specific liquidation threshold, which is a percentage (e.g., 75% for ETH) representing the maximum loan-to-value (LTV) ratio at which the position remains safe. The formula is: Health Factor = (Total Collateral Value in USD * Liquidation Threshold) / Total Borrowed Value in USD. If the Health Factor drops to or below 1.0, the position becomes undercollateralized, triggering an automatic liquidation event. In this event, a portion of the user's collateral is sold, often at a discount, to repay the debt and restore the protocol's solvency.

Users must actively monitor their Health Factor, as it fluctuates with market volatility. A drop in the price of deposited collateral assets or an increase in the value of borrowed assets can rapidly decrease the HF. To improve a low Health Factor, a user can either deposit more collateral or repay a portion of their debt. This metric is fundamental to the overcollateralized lending model, allowing protocols to offer permissionless loans without credit checks by algorithmically enforcing solvency through the threat of automated liquidation.

Different protocols implement slight variations. For example, MakerDAO uses a similar concept called the Collateralization Ratio, where values above 150% are typically safe. Understanding Health Factor is critical for DeFi participants, as mismanagement can lead to significant losses during liquidations, especially in volatile markets where prices can move swiftly past the liquidation threshold, sometimes resulting in liquidation cascades across the ecosystem.

The Health Factor (HF) is a numerical ratio that indicates the risk level of a borrower's position in a decentralized lending protocol. It is calculated as the Total Collateral Value divided by the Total Borrowed Value, adjusted by the collateral's Liquidation Threshold. A position is considered safe when its Health Factor is greater than 1.0. If the HF falls to or below 1.0, the position becomes undercollateralized and is subject to liquidation, where a portion of the collateral is automatically sold to repay the debt and restore protocol solvency.

The calculation incorporates the Loan-to-Value (LTV) ratio concept but is its inverse. For example, if a user deposits $10,000 of ETH (with a 75% liquidation threshold) as collateral and borrows $5,000 of USDC, the Health Factor is calculated as: ($10,000 * 0.75) / $5,000 = 1.5. This buffer protects the protocol from market volatility. Key factors that cause the HF to decrease include a drop in the collateral asset's price, an increase in the borrowed asset's value, or the protocol adjusting risk parameters like the liquidation threshold.

Users must actively monitor their Health Factor to avoid liquidation. Most protocols display this metric prominently and allow users to perform risk mitigation actions. These include depositing more collateral, repaying a portion of the borrowed assets, or converting the position to a safer collateral type. A higher Health Factor (e.g., 2.0 or above) provides a greater safety cushion against market fluctuations. The specific liquidation threshold and penalties vary by protocol and asset, making it critical for users to understand the exact terms of their chosen platform.

The health factor (HF) is a numerical value calculated by a lending protocol to assess the risk of a borrower's position becoming undercollateralized. It is defined as the ratio of the total collateral value, adjusted by its liquidation threshold, to the total borrowed value. The generic formula is: Health Factor = (Total Collateral Value * Liquidation Threshold) / Total Borrowed Value. A health factor above 1.0 indicates a safe position, while a value at or below 1.0 triggers liquidation, where collateral is automatically sold to repay the debt.

The calculation's components are critical. The Total Collateral Value is the sum of all deposited assets, priced by the protocol's oracle. Each asset has a Liquidation Threshold—a percentage (e.g., 80% for ETH) representing the maximum borrowable value against it. Multiplying these gives the "borrowable value" of the collateral. The Total Borrowed Value is the sum of all outstanding loans plus accrued interest, denominated in the protocol's base currency. This formula dynamically updates with market price movements, making the health factor a real-time risk indicator.

For example, a user deposits 1 ETH as collateral when ETH is worth $3,000. If ETH's liquidation threshold is 75%, the borrowable value is $2,250. If the user borrows $1,000 of a stablecoin, the health factor is ($3,000 * 0.75) / $1,000 = 2.25. If ETH's price drops to $1,500, the health factor falls to ($1,500 * 0.75) / $1,000 = 1.125, moving closer to the liquidation threshold of 1.0. This demonstrates the sensitivity of the health factor to volatility.

Maintaining a healthy health factor is a primary concern for DeFi users. Strategies include - depositing additional collateral, - repaying a portion of the borrowed assets, or - using less volatile collateral assets. Protocols like Aave and Compound display this metric prominently in their interfaces. A high health factor provides a buffer against market swings, while a low one risks a liquidation event, which can incur substantial penalty fees for the borrower.

The health factor formula is foundational to overcollateralized lending in DeFi. It automates risk management without intermediaries, enabling the trustless issuance of loans. Understanding this calculation is essential for developers building on these protocols, analysts assessing systemic risk, and users managing leveraged positions. It directly links collateral volatility, debt accumulation, and liquidation mechanics into a single, actionable metric.