Awarded once after a correct answer.
Trace repayment and collateral seizure
Useful first : Collateral, LTV and liquidation thresholds · DeFi interest rates: APR and APY
Reading path · 19 / 41 · Intermediate
The health factor compares threshold-weighted collateral with debt; below one, liquidation can become eligible.
The essentials
The health factor is threshold-weighted collateral value divided by total debt value. Below one, a position becomes eligible for liquidation. A liquidator can repay eligible debt and receive collateral with a protocol-defined bonus.
How it works
The permitted liquidation fraction depends on the version and market conditions. Liquidation is not a stop-loss promising a particular exit price. Price gaps, oracle behaviour and congestion can make an apparently manageable position deteriorate before an owner can react.
What to watch
Adding collateral or repaying debt improves the ratio if other inputs stay fixed. Correlation changes, stablecoin depegs and accrued interest can undermine the buffer. Our simulator isolates one collateral value with fixed debt and threshold; it does not reproduce every parameter, liquidation cost or execution constraint in a live market.
Understand the details
Liquidation is a protocol-permitted action when a position meets specified conditions. A liquidator repays eligible debt and receives collateral according to the market’s rules, often with an incentive. It is not necessarily a sale of the entire position, and the permitted fraction can depend on the deployment and position state.
Boundaries and common mistakes
Health factor is a snapshot, not a timer. Fast prices, oracle updates, debt accrual and transaction congestion can change the outcome before a protective transaction executes. Liquidation incentives do not guarantee profitable participation during every market shock; insufficient liquidity can create bad-debt risk.
The mechanism at a glance
- 01Position eligible
- 02Liquidator repays debt
- 03Collateral transferred
- 04Remaining position recalculated
Read these as connected concepts, not necessarily consecutive steps.
Read the explanation
Liquidation is a protocol-permitted action when a position meets specified conditions. A liquidator repays eligible debt and receives collateral according to the market’s rules, often with an incentive. It is not necessarily a sale of the entire position, and the permitted fraction can depend on the deployment and position state.
Put the mechanism into context
In a toy liquidation, a liquidator repays 100 units and receives collateral valued at 105. Ignore protocol fees, slippage and caps. Make a before/after table for borrower debt, borrower collateral and liquidator cash flows. The 5% incentive is fictional.
Apply it in the workshop →What this mechanism does not guarantee
Health factor is a snapshot, not a timer. Fast prices, oracle updates, debt accrual and transaction congestion can change the outcome before a protective transaction executes. Liquidation incentives do not guarantee profitable participation during every market shock; insufficient liquidity can create bad-debt risk.
The distinction that changes the analysis
A liquidation changes both sides of the position: some debt is repaid and collateral is transferred under the applicable rules. Looking only at the lower debt balance hides the collateral loss. Reconstruct both movements before assessing the remaining position.
Explain it yourself
Revisit the case above. Name what is established, what remains to be checked and the evidence needed to conclude. A strong answer addresses both sides of the diagram.
Apply the lesson to a case
In a toy liquidation, a liquidator repays 100 units and receives collateral valued at 105. Ignore protocol fees, slippage and caps. Make a before/after table for borrower debt, borrower collateral and liquidator cash flows. The 5% incentive is fictional.
No. The collateral must be valued or sold under real conditions, and gas, slippage or price moves can exceed the nominal incentive. The borrower loses collateral while debt decreases. Distinguish accounting value from executable sale proceeds and avoid interpreting the example as a trading strategy.
Try the health factor simulator →
Check your understanding
HF = 7,000 × 0.80 / 6,000 ≈ 0.933. The position is below one in this simplified model.
Terms in this lesson
- Oracle
- A mechanism that supplies a contract with information originating outside its immediate execution context.
- Health factor
- Threshold-weighted collateral value divided by debt value in the Aave model described here.
Prepare a correction note
Describe the passage and the proposed correction. This creates a local note for you to share; it sends nothing. Do not include personal or confidential information.