Health Factor

The Health Factor (HF) is calculated as the ratio of the Total Collateral Value to the Total Borrowed Value, adjusted for each asset's Loan-to-Value (LTV) ratio. The formula is typically:

HF = (Σ Collateral Amount * Collateral Price) / (Σ Borrowed Amount * Borrowed Price)

Where each collateral and borrowed asset is weighted by its specific risk parameters set by the protocol.

A Health Factor of 1.0 is the critical boundary. When HF ≤ 1.0, the position becomes eligible for liquidation.

• Below 1.0: The collateral value is insufficient to cover the debt at the protocol's defined risk ratios, triggering a liquidation event.
• Above 1.0: The position is considered safe, with a buffer against market volatility. Protocols often set a Liquidation Threshold slightly above 1.0 (e.g., 1.1) for different assets to account for price feed latency.

Health Factor is not static; it fluctuates in real-time based on:

• Market Price Movements: Changes in the oracle-reported price of collateral or borrowed assets.
• Debt Accumulation: Taking on additional debt decreases the HF.
• Collateral Deposition: Adding collateral increases the HF.
• Interest Accrual: As interest compounds on borrowed assets, the debt increases, gradually lowering the HF over time if not managed.

Protocols assign unique risk parameters to each supported asset, which directly impact the Health Factor calculation:

• Loan-to-Value (LTV): Maximum borrowing power against collateral (e.g., 80% for ETH).
• Liquidation Threshold: The HF level at which liquidation is triggered for that asset.
• Liquidation Penalty: A fee applied during liquidation. A position with riskier collateral (lower LTV) will have a lower effective Health Factor for the same debt amount.

The HF serves as the central dashboard metric for users and protocols:

• For Users: A real-time gauge of position safety. Users can add collateral or repay debt to increase their HF.
• For Protocols: An automated trigger for the liquidation engine, ensuring the protocol remains over-collateralized and solvent.
• For Liquidators: Identifies under-collateralized positions to arbitrage, paying off debt in exchange for discounted collateral.

A Safety Buffer is the practical margin users maintain above HF = 1.0 to avoid liquidation from normal market volatility. It is often expressed as a percentage or absolute HF value.

• Example: A user with an HF of 2.0 has a 100% safety buffer.
• Best Practice: Maintaining a high safety buffer (e.g., HF > 1.5) is crucial during periods of high market volatility to account for sudden price drops and liquidation cascades.

Despite different calculations, all protocols trigger liquidation to protect solvency. The primary triggers are:

• Health Factor/Collateral Ratio ≤ Liquidation Threshold: The standard case due to market movements.
• Oracle Price Updates: A sharp price drop in collateral or rise in borrowed asset value, as reported by the oracle.
• Interest Accrual: For protocols with compounding interest (like Compound, Aave), the growing debt can slowly push HF downward.
• Protocol-wide Emergency States: Like Liquity's Recovery Mode or Aave's freeze actions, which can change parameters globally.

Depositing additional collateral assets into a lending protocol increases the total value of the user's collateral. This directly increases the numerator in the Health Factor calculation, thereby raising the Health Factor and improving the safety margin against liquidation.

• Example: Adding 1 ETH as collateral when ETH is worth $3,000 increases your collateral value by $3,000.
• This is the primary action to recover a low Health Factor.

Withdrawing collateral reduces the total value securing the loan. This decreases the numerator in the Health Factor formula, lowering the Health Factor and bringing the position closer to the liquidation threshold.

• Key Risk: This action can trigger immediate liquidation if the resulting Health Factor falls below 1.0.
• Protocols often prevent withdrawals that would make the Health Factor unsafe (e.g., below 1.1).

Taking out a new loan or increasing an existing debt position increases the total borrowed value. This increases the denominator in the Health Factor calculation (adjusted for asset-specific Loan-to-Value ratios), which lowers the Health Factor.

• The impact is magnified by the LTV factor of the borrowed asset.
• Example: Borrowing a stablecoin with a 75% LTV has a greater negative impact on HF than borrowing an asset with a 50% LTV, for the same dollar amount.

Repaying borrowed assets (principal or interest) reduces the total debt owed. This decreases the denominator in the Health Factor calculation, which raises the Health Factor and improves the position's safety.

• This is the most direct way to improve a low Health Factor aside from adding collateral.
• Partial repayments provide a proportional improvement.

While not a direct user action, the oracle-reported price of collateral and borrowed assets constantly changes. A drop in collateral value or a rise in borrowed asset value decreases the Health Factor.

• Users must monitor price feeds as external market movements can silently degrade their Health Factor.
• This is why volatile assets have lower LTV ratios to create a larger safety buffer.

When Health Factor falls below the protocol's liquidation threshold (typically 1.0), a liquidation is triggered. This is a forced action by the protocol or liquidators that:

• Sells a portion of the user's collateral at a discount to repay their debt.
• Charges a liquidation penalty (e.g., 5-15%).
• The goal is to restore the Health Factor above 1.0, often leaving the user with significantly less collateral.

A Health Factor (HF) is a numerical ratio that measures the safety of a collateralized debt position (CDP). It is calculated as (Collateral Value * Collateral Factor) / Borrowed Value. A value above 1.0 indicates a safe position, while a value at or below 1.0 triggers liquidation. This mechanism ensures the protocol remains over-collateralized.

When the Health Factor drops to the liquidation threshold (e.g., 1.0), the position becomes eligible for liquidation. This occurs when:

• The collateral value falls (e.g., market crash).
• The borrowed value rises (e.g., stablecoin depeg). A liquidator repays part of the debt in exchange for seized collateral at a liquidation penalty, restoring the HF above 1.0.

Several variables impact HF stability and liquidation risk:

• Volatility: High volatility in collateral assets causes rapid HF fluctuations.
• Collateral Factor (LTV): The maximum loan-to-value ratio set by the protocol; a lower factor provides a larger safety buffer.
• Oracle Risk: HF relies on price oracles. Stale or manipulated prices can cause inaccurate HF calculations and unjust liquidations.
• Interest Rates: Variable borrow rates can increase the debt balance over time, slowly eroding the HF.

Users must actively monitor their HF to avoid liquidation. Mitigation strategies include:

• Adding Collateral: Depositing more assets to increase the numerator.
• Repaying Debt: Reducing the borrowed amount to decrease the denominator.
• Using Safer Assets: Choosing less volatile collateral with higher collateral factors.
• Automated Tools: Utilizing liquidation protection services or setting up wallet alerts for HF thresholds.

While the core concept is universal, implementations differ:

• Aave: Uses a single HF; positions are liquidated down to an HF of 1.0.
• Compound: Uses a related Collateral Factor and Liquidation Threshold; liquidation occurs when Borrowed Value > Collateral Value * Liquidation Threshold.
• MakerDAO: Uses a Collateralization Ratio (inverse of LTV) and a Liquidation Ratio; Vaults are liquidated via auctions when the ratio falls below the required minimum.

Health Factor interacts with other key security concepts:

• Loan-to-Value (LTV): The inverse of the collateral factor; the maximum borrow amount against collateral.
• Liquidation Bonus/Penalty: The discount liquidators receive on seized collateral, which is a cost to the borrower.
• Liquidation Close Factor: The maximum percentage of a borrow that can be liquidated in a single transaction (e.g., 50% on Compound).
• Safety Buffer: The practical margin (e.g., maintaining HF > 1.5) users should target above the protocol minimum.

The forced sale of a borrower's collateral when their Health Factor drops below 1.0. This process is triggered by a liquidation bot or keeper to repay the outstanding debt and protect the protocol's solvency. The borrower typically incurs a liquidation penalty, and the liquidator receives a liquidation bonus as an incentive.

• Example: On Aave, a user with ETH collateral and a USDC loan may have their ETH sold if its price drops sharply.

The maximum percentage of an asset's value that can be borrowed against, set by the protocol's governance. It is the inverse of the Loan-to-Value (LTV) ratio. A lower collateral factor means less borrowing power but also lower risk.

• Key Relationship: This factor directly determines the initial Health Factor. For example, with a 75% LTV, borrowing $75 against $100 of collateral gives a starting Health Factor of 1 / 0.75 = ~1.33.

The specific Health Factor level (e.g., 1.0) at which a position becomes eligible for liquidation. It is distinct from the Liquidation Bonus (the incentive for liquidators) and the Liquidation Penalty (the fee paid by the borrower). Some protocols have a liquidation buffer or use a liquidation threshold that is higher than 1.0 to provide an early warning margin.

Mechanisms designed to backstop protocol insolvency from bad debt, often funded by staking native tokens. While not directly part of an individual's Health Factor calculation, these modules (like Aave's Safety Module or MakerDAO's Surplus Buffer) provide a systemic layer of protection against under-collateralization and liquidation cascades that could threaten the entire lending pool.

The external data source that provides real-time market prices for collateral and debt assets. The accuracy and latency of the oracle (e.g., Chainlink) are critical, as the Health Factor is calculated using these prices. Oracle manipulation or price feed lag can cause inaccurate Health Factor readings and lead to unfair liquidations or under-collateralized positions.

A protocol-level limit on the total amount that can be borrowed against a specific collateral asset. It mitigates concentration risk and systemic risk. While it doesn't affect an individual's Health Factor calculation, hitting a debt ceiling can prevent users from opening new positions or adding collateral to existing ones, indirectly impacting their ability to manage health.