DeFi collateral: how health factor and liquidation work

A DeFi borrowing position can become eligible for liquidation even when nobody has borrowed another token. Collateral prices, debt prices, accumulated interest and protocol settings can all change its condition. Aave's health factor brings several of these inputs into one ratio, but it does not measure every risk of using a lending protocol.

This explainer uses Aave V3's collateral framework. Other lending protocols, and other Aave versions, can apply different rules. A calculation is meaningful only when its market, assets and configuration are identified.

What the health factor measures

Aave expresses health factor as collateral value multiplied by the weighted average liquidation threshold, divided by total debt value. A value below 1 makes a position eligible for liquidation under this framework. The figure describes the position at the values used by the protocol; it is neither an insurance policy nor a prediction. Aave's health-factor guide explains this relationship.

For multiple collateral assets, the equivalent calculation is:

Health factor = [sum of (eligible collateral value × its liquidation threshold)] ÷ total debt value.

The multiplication happens separately for each collateral before adding the results. A simple average of asset thresholds would incorrectly give a small holding the same influence as a large one. Aave's risk-parameter documentation sets out this weighted calculation.

Borrowing limits and liquidation thresholds are different

Aave's V3 reserve documentation distinguishes loan-to-value, or LTV, from the liquidation threshold. LTV governs how much borrowing the collateral permits. The liquidation threshold governs when the resulting position becomes eligible for liquidation. Reserve caps and other restrictions can also constrain borrowing.

Consider an entirely hypothetical single-asset market with a 65% LTV and a 78% liquidation threshold. Against collateral valued at $12,000, the LTV-based borrowing amount would be $7,800, assuming no other restriction. The liquidation boundary corresponds to $9,360 of debt at that unchanged collateral value. The difference does not authorize a borrower to open a $9,360 loan.

These percentages are invented for illustration, not quoted settings for any token. Parameters can differ between markets and change through governance. A token name alone is therefore insufficient to identify its borrowing rules.

Work through a hypothetical position

Suppose eligible collateral consists of $9,000 of asset A with a 75% threshold and $3,000 of asset B with an 85% threshold. Total debt is worth $6,000. All figures below are hypothetical; the scenario holds thresholds constant.

Now suppose A falls 30%, B is unchanged and debt value rises 10%. Adjusted collateral becomes $4,725 + $2,550 = $7,275. Debt becomes $6,600. Health factor falls to approximately 1.102.

This arithmetic shows why watching only the largest collateral asset is incomplete. The debt side matters too. It also shows why a percentage price change cannot be translated directly into the same percentage change in health factor when several inputs move together.

The inputs keep changing

Debt is an outstanding token obligation, not simply the original dollar amount borrowed. Aave's variable-debt-token documentation describes the balance as principal plus accrued interest. Holding other inputs fixed, a growing debt balance reduces health factor.

The rate itself can move. Aave's interest-rate strategy calculates variable borrowing rates from reserve conditions and configured slopes. A displayed annualized rate is a current input, not a promise that the same rate will apply throughout the loan.

Asset valuation also follows the market's configured price sources. The oracle documentation exposes both an asset's price and its source. A price on an unrelated trading screen is not sufficient to reproduce the protocol's calculation.

Configuration deserves its own check. Efficiency Mode uses category-specific LTVs, liquidation thresholds and borrowing permissions. A worksheet built for standard collateral settings may be wrong for a position using E-mode.

What liquidation actually changes

An eligible liquidation lets a liquidator repay debt and receive collateral, including the applicable liquidation bonus. Eligibility does not mean a fixed percentage of every account will always be liquidated. Aave's current guide makes permitted amounts depend on health factor and position size, with additional rules concerning small remaining balances. The exact deployed version and market rules matter.

Nor does crossing the boundary create a guaranteed grace period. A pending repayment and a confirmed repayment are different states. Aave's repayment guide allows full or partial repayment and describes approval and confirmation steps; the position changes when the repayment is confirmed.

Build a worksheet that can be checked

A useful record connects the headline number to observable inputs. It should make another reader able to reconstruct the calculation instead of merely copying a dashboard screenshot.

Label stress cases as assumptions, not forecasts. Change one input at a time before combining shocks, and retain the starting snapshot so that the differences remain explainable.

Finally, a favorable health factor does not resolve software, oracle or network failures. Aave's risk documentation treats these separately from collateral risk. If a protocol incident occurs, distinguishing confirmed events from estimates remains essential; our guide to reading a crypto security incident report explains that process.

Source review: 22 September 2026. All numerical scenarios are hypothetical.