Loan-to-Value Ratio (LTV)

The Loan-to-Value Ratio (LTV) is a financial metric, expressed as a percentage, calculated by dividing the loan amount by the appraised value of the collateral asset. In traditional finance, this is used for mortgages and auto loans. In decentralized finance (DeFi), it is a critical parameter for overcollateralized lending protocols like Aave and Compound. A lower LTV indicates a larger safety buffer for the lender, as the collateral value significantly exceeds the loan value, reducing the risk of loss if the borrower defaults or the collateral's price declines.

In practice, protocols set a maximum LTV for each supported asset, which acts as a borrowing limit. For example, if ETH has a maximum LTV of 75% and a user deposits $10,000 worth of ETH as collateral, they can borrow up to $7,500 in another asset, like a stablecoin. This creates an immediate liquidation threshold; if the value of the collateral falls such that the loan's LTV exceeds the maximum, the position becomes eligible for liquidation. A liquidator can repay part of the debt in exchange for the collateral at a discount, protecting the protocol from insolvency.

Managing LTV is crucial for borrower safety. Health Factor is a related metric used by protocols to represent how close a position is to liquidation. It is inversely related to LTV—a falling collateral price or increasing loan debt lowers the Health Factor. Users must monitor their positions and may need to deposit more collateral or repay part of the loan to maintain a safe LTV and avoid liquidation. This mechanism ensures the system remains solvent without requiring credit checks, relying instead on cryptographic enforcement of collateral ratios.

LTV ratios vary by asset based on volatility and liquidity risk. Stablecoins like DAI or USDC often have higher maximum LTVs (e.g., 80-90%) because their price is pegged. More volatile assets like Bitcoin or altcoins have lower maximum LTVs (e.g., 60-75%). This risk-tiering is a fundamental component of a protocol's risk management framework, determined by governance or a risk committee. Understanding LTV is essential for anyone engaging in DeFi lending or borrowing, as it directly dictates borrowing capacity, capital efficiency, and exposure to liquidation risk.

The Loan-to-Value (LTV) ratio is a core risk parameter in decentralized finance (DeFi) that measures the size of a loan against the value of the collateral securing it, expressed as a percentage. It is calculated as (Loan Amount / Collateral Value) * 100. A lower LTV indicates a larger safety buffer for the lender, as the collateral is worth significantly more than the loan. This metric is central to overcollateralized lending, the predominant model in DeFi, where users must lock assets worth more than the amount they wish to borrow to mitigate the volatility of crypto assets.

In practice, a protocol sets a maximum LTV for each supported collateral asset, such as 75% for ETH or 65% for wBTC. If a user deposits $10,000 worth of ETH as collateral, a 75% maximum LTV allows them to borrow up to $7,500 in a stablecoin or another asset. The actual LTV of a position fluctuates with market prices. If the value of the collateral falls or the borrowed amount's value rises, the position's health factor deteriorates, increasing the LTV. Protocols continuously monitor this to protect the solvency of their lending pools.

When market movements cause a position's LTV to exceed the protocol's liquidation threshold, the position becomes eligible for liquidation. This is a critical risk management mechanism where liquidators can repay part or all of the undercollateralized loan in exchange for the collateral at a discount. The process happens automatically via smart contracts to ensure lenders are made whole. For borrowers, this results in a loss of their collateral. Therefore, managing LTV is essential; users often maintain a buffer well below the maximum to avoid liquidation during normal market volatility.

The Loan-to-Value (LTV) ratio is a core risk parameter in a lending protocol that determines the maximum amount a user can borrow against their supplied collateral, expressed as a percentage. It is calculated as (Borrowed Value / Collateral Value) * 100. For instance, if a user deposits $10,000 of ETH as collateral into a pool with a 75% LTV, they can borrow up to $7,500 of another asset, such as a stablecoin. This ratio acts as the primary buffer against price volatility, ensuring the loan remains overcollateralized to protect the protocol and its lenders from losses if the collateral's value declines.

Protocols set LTV ratios on a per-asset basis, reflecting each collateral's risk profile. Highly liquid and stable assets like ETH or WBTC may have LTVs of 75-80%, while more volatile or illiquid assets might be assigned ratios as low as 40-50%. This risk assessment is typically managed by governance or a dedicated risk committee. The LTV is intrinsically linked to the liquidation threshold, which is set slightly lower (e.g., 80% LTV with an 85% liquidation threshold). If a user's position reaches this threshold due to market movements, it becomes eligible for liquidation, where keepers repay part of the debt in exchange for the collateral at a discount to restore the protocol's health.

From an implementation perspective, the LTV ratio is enforced by smart contract logic during the borrowing transaction. The contract will revert the transaction if the resulting debt would exceed the permitted LTV. Real-time oracle price feeds are essential for this calculation, as they provide the current market value of both collateral and borrowed assets. This creates a dynamic system where a user's health factor—a derived metric often calculated as (Collateral Value * Liquidation Threshold) / Borrowed Value—constantly fluctuates with market prices. Maintaining a health factor above 1 is crucial to avoid liquidation, making LTV the foundational variable in this risk equation.