Health Factor

The Health Factor (HF) is a numerical value, typically expressed as a ratio like 1.5 or 2.0, that indicates the risk level of a user's borrowed position. It is calculated by dividing the total collateral value (in a base currency like USD) by the total borrowed value, often with adjustments for the liquidation threshold of each specific asset. A higher Health Factor signifies a safer, more overcollateralized position, while a value approaching 1.0 indicates imminent liquidation risk. For example, an HF of 2.0 means the collateral value is twice the borrowed value after threshold adjustments.

This metric is the core mechanism that enables permissionless lending without credit checks. Protocols like Aave and Compound continuously monitor this ratio using price oracles. If market volatility causes the value of the collateral to drop or the borrowed debt to increase, the Health Factor decreases. When it falls below a protocol-defined threshold (usually 1.0), the position becomes eligible for liquidation. At this point, keepers or liquidators can repay part of the debt in exchange for seizing the collateral at a discount, protecting the protocol from insolvency.

Users must actively manage their Health Factor to avoid liquidation. This can be done by depositing more collateral, repaying borrowed assets, or using a combination of both. The required minimum Health Factor varies by protocol and can even differ across money markets within the same protocol based on asset risk profiles. It is fundamentally a measure of solvency, ensuring the total value of the lending pool remains greater than the total liabilities, even during periods of high market stress and price slippage.

Understanding the components is key: the Loan-to-Value (LTV) ratio dictates how much can be borrowed initially, while the Liquidation Threshold is the LTV level at which liquidation triggers. The Health Factor dynamically reflects the gap between the current collateralization and this dangerous threshold. Advanced users monitor factors that affect HF, including interest accrual on variable-rate debts, which increases the borrowed amount over time, and the collateral factor of deposited assets, which determines their borrowing power.

The Health Factor (HF) is a numerical value, typically expressed as a ratio like 1.5 or 2.0, that represents the safety margin of a collateralized debt position (CDP) in a lending protocol. It is calculated by dividing the total collateral value (in the protocol's base currency, e.g., USD) by the total borrowed value, adjusted for each asset's liquidation threshold. A formula is often expressed as Health Factor = (Σ Collateral Amount * Collateral Price * Liquidation Threshold) / (Σ Borrowed Amount * Borrowed Price). When this value falls below 1.0, the position becomes undercollateralized and is eligible for liquidation.

The primary function of the Health Factor is to act as a real-time risk indicator for both the borrower and the protocol. For the borrower, it provides a clear gauge of how close their position is to being liquidated. For the protocol, it ensures the overall system remains solvent by triggering liquidations before the debt exceeds the value of the collateral. Key components influencing the HF are volatile asset prices (from oracles), the specific liquidation threshold set by governance for each collateral type (e.g., 80% for ETH, 65% for a riskier asset), and the accrual of borrow interest, which increases the debt side of the equation over time.

Users must actively manage their Health Factor to avoid liquidation. This can be done by depositing more collateral (increasing the numerator) or by repaying borrowed assets (decreasing the denominator). For example, if ETH price drops sharply, the collateral value in a user's position decreases, causing the HF to fall. To restore a healthy buffer, the user might deposit additional ETH. Protocols often display a "liquidation threshold" HF (e.g., 1.1) as a warning, and a "liquidation HF" at exactly 1.0, where any further decrease allows liquidators to repay part of the debt in exchange for seized collateral at a discount.

The Health Factor is intrinsically linked to a protocol's liquidation engine. When HF < 1.0, the position is flagged. Liquidators (often bots) can then repay a portion of the unhealthy debt and receive an equivalent value of the user's collateral, plus a liquidation bonus (or penalty for the borrower). This mechanism incentivizes rapid correction of undercollateralized positions, protecting the protocol from bad debt. Different protocols may implement variations, such as Compound Finance's Collateral Factor (which sets a borrowing limit) and Aave's distinct Health Factor and Loan-to-Value (LTV) ratios, but the core risk-management principle remains consistent.

Understanding and monitoring your Health Factor is a fundamental responsibility in DeFi borrowing. It is not a static number; it fluctuates with market conditions. Best practices include maintaining a significant safety margin above 1.0 (e.g., HF > 1.5), using price alert tools, and understanding the specific risk parameters of your chosen collateral assets. Failure to manage HF can result in a liquidation event, where a portion of your collateral is automatically sold, often at an unfavorable price, to repay your loan and keep the protocol solvent.

The Health Factor (HF) is a numerical metric, typically expressed as HF = (Total Collateral Value * Liquidation Threshold) / Total Borrowed Value. It acts as a real-time solvency ratio for a borrower's position within a decentralized finance (DeFi) lending protocol like Aave or Compound. A health factor greater than 1 (HF > 1) indicates the borrowed assets are sufficiently over-collateralized, keeping the position safe. As the value of the collateral falls or the borrowed debt rises, the health factor decreases, moving closer to the liquidation threshold of 1.

The formula's components are critical: Total Collateral Value is the sum of all deposited assets at current market prices. The Liquidation Threshold is a protocol-set parameter (e.g., 80% for ETH) representing the maximum percentage of the collateral's value that can be borrowed against; it acts as a safety buffer. Total Borrowed Value is the sum of all outstanding loans, plus accrued interest, valued in the same unit (often USD). This structure ensures that a position becomes eligible for liquidation when the borrowed value exceeds the discounted collateral value (HF <= 1), protecting the protocol from undercollateralized debt.

For example, if a user deposits $10,000 of ETH with a 75% liquidation threshold and borrows $5,000 of USDC, their health factor is ($10,000 * 0.75) / $5,000 = 1.5. If ETH's price drops, reducing the collateral value to $7,000, the HF becomes ($7,000 * 0.75) / $5,000 = 1.05. This positions the account dangerously close to liquidation. Monitoring this metric is essential for borrowers to manage risk, often requiring them to add more collateral or repay debt to increase their HF and avoid a costly liquidation event.