What is a health factor in DeFi?

A health factor in DeFi is a gauge of how close a crypto loan is to being liquidated. On lending protocols, people borrow against crypto they deposit as collateral. Because collateral prices move, the protocol needs a quick way to tell whether a loan is still covered. The health factor is that measure, and it is best known from Aave, described in what Aave is.

How is the health factor calculated?

Aave gives the formula as total collateral value multiplied by the weighted average liquidation threshold, divided by total borrow value. The liquidation threshold is a percentage set by Aave governance for each collateral asset.

Aave's own example shows how it works. If someone supplies $10,000 of ether with an 80% liquidation threshold and borrows $6,000 of the stablecoin GHO, the health factor is 10,000 times 0.8 divided by 6,000, or about 1.33. If the value of the ether falls, the top of the fraction shrinks and so does the health factor.

What happens when the health factor drops below 1?

Below 1, the collateral is no longer considered to cover the loan, and the position can be liquidated. Another user, called a liquidator, repays part of the debt and receives an equal value of the borrower's collateral plus a liquidation bonus. Aave says up to 50% of the debt can be liquidated when the health factor is above 0.95 and both collateral and debt are at least $2,000. Up to 100% can be liquidated at 0.95 or below, or when either side is under $2,000. The wider process is covered in what happens if you get liquidated in crypto.

How do you increase your health factor?

Aave lists two ways. Supply more collateral, or repay part of the borrowed amount. Either change raises the number. The health factor also rises on its own if collateral gains value, and falls if collateral loses value or the borrowed asset gains value.

What is a good health factor?

Aave says there is no universally "safe" health factor, because it depends on how volatile the assets are and how closely they move together. A lower figure may be acceptable when collateral and debt are closely linked, such as two stablecoins, than when volatile collateral backs a stablecoin loan.

Other protocols use similar ideas under different names. Compound III, for example, sets a borrow collateral factor for each asset, which caps how much can be borrowed against it, and an account that falls short cannot borrow more until it adds collateral or repays. The general mechanics of borrowing are in crypto lending and borrowing.

This guide explains how the measure works. Liquidation rules and parameters change through governance, so the protocol's current documentation is the reference.