What do loan-to-value, liquidation threshold and health factor mean in crypto lending?

Two limits, not one

Each type of collateral on Aave V3 has its own risk settings.¹

• Loan-to-value (LTV) is the most you can borrow against the collateral's value. Aave's example: a 75% LTV lets you borrow 75% of the collateral's value.¹
• Liquidation threshold is the point at which a loan counts as under-collateralised and could be liquidated. Aave's example: at 80%, that happens once the debt is worth more than 80% of the collateral.²

The threshold is set above the LTV on purpose. Aave's risk documentation calls the gap between them a safety mechanism for borrowers.² So a new loan starts with some room before it can be liquidated.^2,8

Compound uses different words for the same idea. Compound III calls the LTV a "borrow collateral factor". Its example: with an 85% factor for WBTC, you can borrow up to 85% of your WBTC's dollar value.⁹ Its separate, higher "liquidation collateral factors" decide when a loan can be liquidated, which it says gives every new loan a price buffer.⁸

The health factor

Aave sums up a loan's safety in one number, the health factor.³

Health factor = collateral value × liquidation threshold ÷ debt³

Aave gives an example. Supply $10,000 of ether with an 80% liquidation threshold, borrow $6,000, and your health factor is 1.333.³ The sum: $10,000 × 80% = $8,000, and $8,000 ÷ $6,000 = 1.333.³

A health factor below 1 means the loan can be liquidated.³ If you hold several types of collateral, Aave uses a weighted average of their thresholds, weighted by their value.^3,2

What moves it

The health factor changes all the time.^3,4

• Collateral prices. It rises when your collateral gains value and falls when it loses value.³
• Debt. Aave says it also moves with the debt's value and with interest as it builds up.⁴
• Your actions. Aave says you can raise it by supplying more collateral or repaying part of the loan.³

Aave also says there is no universally "safe" health factor. It depends on how volatile your assets are and how closely they move together.³ The BIS authors found that, to avoid liquidation, borrowers usually post more collateral than the minimum.¹⁰

Your liquidation price

For a loan with one type of collateral, you can turn Aave's formula round. The health factor is exactly 1 when the collateral's price falls to a level we call the liquidation price.³

Liquidation price = debt ÷ (number of collateral tokens × liquidation threshold)³

This is our rearrangement of Aave's formula, not a term Aave defines, and it ignores interest added later.³ Module 22 does a similar sum for DAI vaults.

The numbers differ by asset

Settings depend on how risky an asset is. Aave's risk documentation, last edited in 2023, said stablecoins and ether had the highest settings then, a 75% LTV and an 80% threshold, while the most volatile assets had much lower ones.² Settings change over time and between markets, so check the current figures.¹

Aave's efficiency mode, or E-Mode, allows a higher LTV when you supply and borrow assets in the same group, such as dollar stablecoins.⁴