Health factor

A health factor is the normalized version of the collateralization ratio weighted by liquidation thresholds. It is calculated as the sum of each asset's collateral multiplied by its price and its liquidation threshold, divided by the sum of the debt multiplied by its price. A value above one signals a safe position; a value below one makes it eligible for liquidation. The liquidation threshold is set by governance per asset and represents the maximum percentage of value that counts as backing. For example, 10,000 dollars in ETH with an 80 percent threshold and 6,000 dollars of debt gives a health factor of 1.333.

The indicator matters because it is the risk gauge a user watches to avoid liquidation. It drops as debt rises or as the collateral price falls, and it is the basis of the calculation that liquidation bots run. In Aave v3, up to 50 percent of the debt is liquidatable if the factor is above 0.95 and both collateral and debt exceed 2,000 dollars, and up to 100 percent if the factor falls to 0.95 or below.

Aave coined the term health factor, and equivalent concepts exist in Compound, Spark, Morpho and Venus. It is worth verifying the liquidation limits in force in the deployed version, since newer versions may introduce a different liquidation engine. In the European Union, lending services on crypto-assets are assessed case by case within the MiCA perimeter and the applicable financial rules.