Liquidation is an enforced reduction of debt

Start with: collateral.

Liquidation lets a protocol reduce an undercollateralized debt by transferring or selling collateral under its rules. It protects the lending system and can impose a penalty or discount on the borrower.

A health-factor example

Aave-style health factor compares threshold-adjusted collateral with debt:

health factor = sum(collateral value × liquidation threshold) ÷ total debt value

With one collateral worth $10,000, an illustrative 80% threshold and $2,000 debt, the result is 4. If that collateral falls to $2,500, the result reaches 1. A health factor below 1 makes positions eligible for liquidation in this model. This is an illustration, not a safe target or a universal market formula.

The 80% figure is not a recommended threshold and must not be copied into a live borrowing decision. Markets can change parameters. Interest, depegs and oracle updates can move the ratio without a new transaction from you.

Why alerts are not enough

Notifications can arrive late. A congested network, unavailable interface or missing fee asset can prevent a timely repayment. Partial liquidation, penalties and eligible debt amounts vary by protocol and position.

Repaying debt or adding eligible collateral may improve health, but a buffer never removes contract or asset risk. Keep a practical exit plan and consider whether you can repay without selling the same falling asset.

❓ If debt rises while collateral stays constant, what happens to health factor?

It falls. Monitoring only the collateral price misses part of the risk. Use Check a lending position's health factor to model both sides.

Sources

• Aave health factor and liquidations