Health Factor

What Is Health Factor?

The health factor is a numerical score used by lending protocols like Aave and Compound to quantify how safe a borrowing position is. It represents the ratio of a user's collateral value (weighted by each asset's liquidation threshold) to their total outstanding debt. A health factor of 2.0 means the borrower's risk-adjusted collateral is worth twice their debt. A health factor of 1.0 means the position is on the edge of liquidation.

The concept exists because DeFi lending is overcollateralized: borrowers must deposit more value than they borrow. The health factor tracks whether that overcollateralization buffer remains sufficient. When collateral prices drop or debt grows through accrued interest, the health factor decreases. If it crosses below 1.0, third parties can repay a portion of the borrower's debt in exchange for their collateral at a discount.

How It Works

The health factor formula weights each collateral asset by its protocol-assigned liquidation threshold before comparing against total debt:

Health Factor = Sum(Collateral_i * LiquidationThreshold_i) / TotalDebt

Where:
  Collateral_i       = USD value of each deposited collateral asset
  LiquidationThreshold_i = maximum debt ratio for that asset (e.g., 0.83)
  TotalDebt          = total USD value of all outstanding borrows

A Practical Example

Suppose a user deposits 5 ETH (at $2,000 each) and borrows 6,000 USDC. ETH has a liquidation threshold of 83% on Aave v3:

Collateral value  = 5 ETH * $2,000 = $10,000
Risk-adjusted     = $10,000 * 0.83 = $8,300
Total debt        = $6,000

Health Factor     = $8,300 / $6,000 = 1.383

At a health factor of 1.383, the position is safe. Now imagine ETH drops to $1,500:

Collateral value  = 5 ETH * $1,500 = $7,500
Risk-adjusted     = $7,500 * 0.83 = $6,225
Total debt        = $6,000

Health Factor     = $6,225 / $6,000 = 1.0375

The health factor has dropped to 1.04: still above 1.0, but dangerously close. If ETH falls another $50 to $1,450:

Collateral value  = 5 ETH * $1,450 = $7,250
Risk-adjusted     = $7,250 * 0.83 = $6,017.50
Total debt        = $6,000

Health Factor     = $6,017.50 / $6,000 = 1.003

At this point, any further decline triggers liquidation. The borrower has three options to restore their health factor: deposit more collateral, repay some of the debt, or swap collateral into a less volatile asset with a higher liquidation threshold.

Liquidation Thresholds by Asset

Different assets receive different liquidation thresholds based on their volatility, liquidity depth, and oracle reliability. On Aave v3 (Ethereum mainnet), typical values include:

The gap between Max LTV and Liquidation Threshold acts as a safety buffer. For WETH, a borrower can take on debt up to 80.5% of their collateral value, but liquidation does not trigger until debt reaches 83%. This buffer gives borrowers time to react before their position becomes liquidatable. These parameters are subject to change via protocol governance votes.

Efficiency Mode

Aave v3 introduced Efficiency Mode (E-Mode) for borrowing correlated assets. When both the collateral and borrowed asset belong to the same category (for example, USDC collateral and USDT debt), the protocol applies significantly higher thresholds. Stablecoin E-Mode allows liquidation thresholds up to approximately 95.8% and LTV up to 93.8%, reflecting the low relative volatility between correlated assets.

How Compound Handles It

Compound does not use the term "health factor" directly, but implements an equivalent concept. In Compound v2, the Comptroller calculates "account liquidity" and "shortfall":

Account Liquidity = Sum(Supply Balance * Collateral Factor) - Sum(Borrow Balance)

// If shortfall > 0, the account is eligible for liquidation
// This is functionally equivalent to health factor < 1.0

Compound v3 (Comet) simplified this further with an isLiquidatable() function that checks whether a user's collateral weighted by liquidation factors falls below their outstanding debt. Unlike Compound v2, which used a single collateral factor for both borrowing capacity and liquidation eligibility, v3 introduced separate borrowCollateralFactor and liquidateCollateralFactor per asset, creating a buffer similar to Aave's LTV-vs-threshold gap.

The Liquidation Process

When a borrower's health factor drops below 1.0, their position becomes eligible for liquidation. The process is permissionless: anyone can call the liquidation function on the smart contract.

1. Automated bots continuously monitor on-chain positions and detect health factors below 1.0
2. A liquidator calls the protocol's liquidation function, repaying a portion of the borrower's debt using their own funds
3. In return, the liquidator receives an equivalent value of the borrower's collateral plus a liquidation bonus (typically 4.5% to 5% on major assets)
4. The borrower's health factor improves as debt decreases relative to remaining collateral

Close Factor

The close factor determines how much of a position can be liquidated in a single transaction. On Aave v3, the rules are:

• When the health factor is between 0.95 and 1.0 and both collateral and debt exceed $2,000: up to 50% of total debt can be repaid per liquidation
• When the health factor drops to 0.95 or below, or either position is under $2,000: 100% of the debt can be liquidated at once

Compound v3 takes a different approach entirely: its absorb() function seizes all collateral and all debt in one transaction, then resells the collateral via a buyCollateral() discount mechanism.

Use Cases

Position Management

Borrowers use the health factor as their primary dashboard metric for lending protocol positions. Most protocol interfaces display it prominently and color-code it: green for safe (above 2.0), yellow for caution (1.5 to 2.0), and red for danger (below 1.5). Many users set up automated alerts or use on-chain automation tools to add collateral or repay debt when the health factor approaches a personal threshold.

Leveraged Strategies

Traders use health factor calculations to determine maximum leverage. By depositing an asset, borrowing against it, swapping the borrowed asset back into the collateral, and re-depositing, they can create leveraged exposure. The health factor determines how many loops are possible before the position becomes too risky. A flash loan can execute this entire sequence atomically in a single transaction.

Risk Assessment for Protocols

Protocol risk teams and governance participants use aggregate health factor distributions to assess systemic risk. A high concentration of positions with health factors between 1.0 and 1.1 signals vulnerability to a liquidation cascade, where one wave of liquidations depresses prices and triggers the next. For deeper analysis of these dynamics, see the research on collateralized lending models and stablecoin-backed lending platforms.

Risks and Considerations

Oracle Dependency

The health factor relies entirely on oracle price feeds to value collateral and debt. If an oracle delivers a stale or manipulated price, the health factor calculation becomes unreliable. Oracle manipulation attacks have historically triggered incorrect liquidations or prevented liquidations that should have occurred. Most major protocols use Chainlink's decentralized oracle network with circuit breakers to mitigate this, but the dependency remains a fundamental risk.

Sudden Price Movements

The health factor can drop from safe to liquidatable in minutes during volatile markets. A flash crash in ETH, for example, instantly reduces the collateral side of the equation. Borrowers who manage positions manually may not react in time. Even automated systems face risks during periods of extreme network congestion, when the gas cost of a rescue transaction may spike or the transaction may not confirm quickly enough.

Liquidation Penalty

Borrowers whose positions are liquidated lose a portion of their collateral as a penalty (the liquidation bonus paid to the liquidator). This penalty ranges from 4.5% to 10% or more depending on the asset and protocol. For large positions, this can represent substantial losses. The penalty exists to incentivize liquidators, but it means borrowers pay a steep price for letting their health factor drop below 1.0.

Multi-Collateral Complexity

When a position uses multiple collateral assets, the health factor becomes a weighted average across all of them. A borrower might have a comfortable health factor overall, but if one volatile collateral asset drops sharply while their stablecoin collateral holds steady, the aggregate number can be misleading. Understanding the liquidation price for each individual collateral asset provides a more granular risk picture.

Interest Rate Drift

Even without price changes, the health factor gradually decreases as borrowing interest accrues. Variable-rate loans on protocols like Aave can see interest rates spike during periods of high utilization, accelerating the health factor decline. Borrowers who set and forget positions may find their health factor has eroded over weeks or months purely from accrued interest.

This glossary entry is for informational purposes only and does not constitute financial or investment advice. Always do your own research before using any protocol or technology.