Monitoring & Health Check

Health Factor (HF) is the core metric that determines liquidation risk. It's calculated as the ratio of the collateral value to the borrowed value, factoring in asset-specific Loan-to-Value (LTV) ratios. A position becomes eligible for liquidation when its Health Factor drops below 1.0. Bots and keepers constantly scan the blockchain for these undercollateralized positions. For example, a user might deposit 10 ETH (valued at $30,000) as collateral with a 75% LTV to borrow $15,000 worth of a stablecoin. The initial HF is 2.0 ($30,000 * 0.75 / $15,000). If ETH's price plummets to $2,000, the collateral value drops to $20,000, and the HF falls to 1.0 ($20,000 * 0.75 / $15,000), putting the position at the liquidation threshold.

• Sub-step 1: Fetch real-time prices from an oracle like Chainlink for all collateral and debt assets.
• Sub-step 2: Calculate the current Health Factor for every open position using the formula: HF = (Σ Collateral_i * Price_i * LTV_i) / Total Borrowed Value.
• Sub-step 3: Flag any position where HF < 1.0 and add it to a public mempool for liquidators.

Tip: Users can monitor their own HF via protocol frontends and should add more collateral or repay debt if it approaches 1.0 to avoid liquidation.

Liquidation Trigger & Incentive Calculation

The trigger is purely algorithmic: a smart contract function, often checkLiquidationPossible(address user), returns true when the Health Factor is below the threshold. The protocol then calculates a liquidation bonus (or incentive) for the liquidator. This is a discount on the seized collateral, typically between 5% and 15%, making the action profitable. For instance, Aave V3 on Ethereum mainnet offers a 5% liquidation bonus for most assets. The maximum amount that can be liquidated in a single transaction is also capped to prevent market disruption. The exact amount to repay is calculated to bring the user's Health Factor back above 1.0, often to a liquidation close factor like 1.1 for safety.

• Sub-step 1: Call the protocol's getUserAccountData(userAddress) view function to confirm HF < 1.0.
• Sub-step 2: Determine the liquidation bonus from the protocol's parameters, e.g., liquidationBonus = 10500 for a 5% bonus (basis points).
• Sub-step 3: Calculate the debt to be repaid, up to 50% of the user's total debt, using the formula: debtToCover = min(userTotalDebt * closeFactor, maxLiquidationAmount).

Tip: Liquidators use sophisticated bots to be the first to call the liquidation function, as transactions are processed on a first-come, first-served basis.

Execution & Collateral Seizure

The liquidator initiates the liquidation by calling a function like liquidationCall(address collateralAsset, address debtAsset, address user, uint256 debtToCover, bool receiveAToken). They must first approve the protocol to spend the stablecoin or debt asset they will use for repayment. The smart contract then executes an atomic swap: it takes the liquidator's repayment tokens, burns the equivalent debt from the user's position, and transfers a corresponding amount of the user's collateral to the liquidator at a discount. The seized collateral amount is debtToCover / (collateralPrice * (1 - liquidationBonus)). For example, to cover $1,000 of debt with ETH at $2,000 and a 5% bonus, the liquidator receives 1000 / (2000 * 0.95) = 0.5263 ETH, worth $1,052.63, netting a $52.63 profit.

• Sub-step 1: Approve the debt token (e.g., USDC) for the protocol contract 0x... for the debtToCover amount.
• Sub-step 2: Construct and send the liquidation transaction with precise gas settings to outcompete other bots.
• Sub-step 3: The contract verifies the position's health, executes the swap, and emits a LiquidationCall event.

Tip: Failed transactions due to slippage or being outbid are common; liquidators often use flash loans to fund large repayments without upfront capital.

Post-Liquidation State & Penalties

After a successful liquidation, the user's debt is reduced, and their collateral is decreased. The primary penalty is the loss of their collateral at a discount. The protocol recalculates the user's new Health Factor. If the partial liquidation was sufficient to bring HF above 1.0 (e.g., to 1.1), the position becomes safe again. If not, it remains eligible for further liquidation until the debt is fully cleared or the HF is restored. Some protocols may charge an additional liquidation penalty fee on top of the bonus, which is sent to the protocol's treasury or reserve pool. The user's account data is updated on-chain, and they can interact with their position again, though they may face a bad debt scenario if their collateral is completely exhausted.

• Sub-step 1: Query the user's updated account data to verify the new HF: aaveProtocol.getUserAccountData(userAddress).
• Sub-step 2: Check if the position is still undercollateralized (HF < 1.0), requiring another liquidation round.
• Sub-step 3: Monitor for any protocol-specific penalties, such as a 10% fee on the liquidated amount sent to address 0x8d2....

Tip: Users should immediately assess their remaining position after a liquidation to decide whether to deposit more collateral, repay more debt, or close the position entirely to avoid further losses.

Detailed Instructions

Your loan's safety is governed by the Health Factor (HF), a numerical representation of your collateral's value relative to your debt. It is calculated as (Collateral Value * Liquidation Threshold) / Total Borrowed Value. A Liquidation Threshold is a percentage (e.g., 80% for ETH) set by the protocol, representing the maximum loan-to-value (LTV) ratio before your position becomes eligible for liquidation. When the HF drops below 1.0, your position is undercollateralized and can be liquidated.

• Monitor your Health Factor: Regularly check your HF on the protocol's dashboard or via blockchain explorers. For Aave on Ethereum mainnet, you can query a user's health factor using a call to the LendingPool contract at 0x7d2768dE32b0b80b7a3454c06BdAc94A69DDc7A9.
• Know your asset thresholds: Different collateral assets have different liquidation thresholds. For example, on Aave v3, USDC might have an 85% threshold while a volatile altcoin might be 65%.
• Calculate manually for critical positions: Use the formula with real-time prices. A simple script can help:

javascriptCopy
// Pseudo-code for Health Factor
const collateralValue = ethBalance * ethPrice;
const borrowedValue = usdcDebt * 1; // Stablecoin price ~1
const liquidationThreshold = 0.80; // 80%
const healthFactor = (collateralValue * liquidationThreshold) / borrowedValue;
console.log(`Health Factor: ${healthFactor}`);

Tip: Always maintain a Health Factor significantly above 1.0 (e.g., >1.5) to create a safety buffer against market volatility.

Detailed Instructions

Liquidation is triggered by a combination of asset price volatility and your Health Factor falling below 1. The primary catalyst is a sharp drop in the value of your collateral assets or a rise in the value of your borrowed assets. Protocols rely on decentralized price oracles (like Chainlink) to feed accurate, tamper-resistant market data into their smart contracts. A sudden 10-15% price swing can be enough to breach the threshold for many positions.

• Track oracle addresses: Know which oracle your protocol uses. For Compound, the PriceOracle proxy is at 0x65c816077C29b557BEE980ae3cC2dCE80204A0C5. Price updates are not instantaneous; there can be a slight delay.
• Understand liquidation incentives: Liquidators are incentivized by a liquidation bonus (or penalty on the borrower). For instance, a 5% bonus means a liquidator can buy $100 worth of your collateral for $95 of debt they repay.
• Set up price alerts: Use external tools (e.g., DeBank, Zapper) or create custom scripts with services like The Graph or Covalent to monitor your collateral prices and HF in real-time.
• Beware of market manipulation: In illiquid markets, "oracle manipulation" attacks can artificially lower the oracle price, triggering unnecessary liquidations.

Tip: Diversify your collateral basket. Using a single volatile asset as collateral significantly increases liquidation risk compared to a mix of stable and volatile assets.

Detailed Instructions

When your Health Factor approaches dangerous levels (e.g., <1.2), you must act swiftly to re-collateralize or repay debt. The most direct actions are adding more collateral or paying back a portion of your loan. Many protocols also allow you to swap collateral directly within the platform to a more stable asset without needing to withdraw.

• Add more collateral: Deposit additional funds into the protocol's smart contract. On MakerDAO, you would execute a join operation for your Vault (0x9B0C...).
• Repay a portion of your debt: Send the borrowed asset back to the protocol. On Compound, you would call repayBorrow on the cToken contract (e.g., cUSDC: 0x39AA39c021dfbaE8faC545936693aC917d5E7563).
• Use in-protocol swaps: On Aave, use the "Swap Collateral" feature, which interacts with decentralized exchanges via the Pool contract at 0x87870Bca3F3fD6335C3F4ce8392D69350B4fA4E2.
• Automate with keepers: Set up a Gelato or Keep3r network task to automatically add collateral from a designated wallet when your HF dips below a predefined level.

Tip: Always keep a reserve of stablecoins or the borrowed asset in a separate wallet specifically for emergency repayments to avoid being caught off-guard.

Detailed Instructions

If liquidation occurs, a liquidator (a bot or user) will repay a portion of your outstanding debt in exchange for a discounted portion of your collateral. The exact amount is governed by the protocol's liquidation close factor, which determines the maximum percentage of your debt that can be liquidated in a single transaction (e.g., 50% on Compound). The liquidator calls a function like liquidateBorrow on the protocol's smart contract.

• The liquidation process: The liquidator sends the borrowed asset to the protocol contract, which then transfers a larger value of your collateral to them. For example, repaying $1000 of debt might grant them $1050 worth of your ETH (with a 5% bonus).
• Check transaction details: After a liquidation, review the transaction on Etherscan. Look for calls to the specific liquidation function and the assets transferred.
• Assess your new position: Your debt is reduced, but your collateral is also reduced. Recalculate your new Health Factor immediately. It may still be below 1.0, making you vulnerable to further liquidations.
• Post-liquidation actions: You must either add substantial collateral or repay more debt to restore a healthy HF > 1.0. Failure to do so will result in repeated liquidations until the position is safe or fully closed.

Tip: Some protocols offer "soft liquidation" or "health factor recovery modes" that give you a grace period. Familiarize yourself with your specific protocol's mechanisms.