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Distinguish borrowing capacity from liquidation margin
Useful first : Aave lending pools and aTokens · How Chainlink Data Feeds work
Reading path · 18 / 41 · Intermediate
Loan-to-value limits the amount that can initially be borrowed against collateral.
The essentials
Loan-to-value limits the amount that can initially be borrowed against collateral. The liquidation threshold determines when a position becomes insufficiently covered. A margin between these parameters provides some room for price movements; they should not be treated as interchangeable.
How it works
For multiple collateral assets, each contributes according to its value and liquidation threshold. Debt is also valued: an increase in the borrowed asset’s price can weaken health even if collateral prices do not fall. Interest accrual gradually changes the denominator as well.
What to watch
With illustrative collateral worth $10,000, an 80% liquidation threshold and $6,000 debt, the health factor is about 1.33. These are teaching assumptions, not a live market configuration. Leaving borrowing capacity unused can create a buffer, but no single buffer is safe under every volatility or liquidity scenario.
Understand the details
Loan-to-value limits new borrowing relative to eligible collateral. A liquidation threshold helps determine when a position becomes liquidatable. These parameters serve different purposes and can differ by asset. A portfolio with several collateral assets uses their respective values and thresholds, not a single arbitrary percentage applied to everything.
Boundaries and common mistakes
Collateral value depends on oracle prices, while debt can change through interest or the borrowed asset’s price. Correlation can reduce some price mismatch but does not eliminate depegging or liquidity risk. Borrowing up to the maximum leaves less room for unfavorable changes than a position with a deliberate buffer.
The mechanism at a glance
- 01Collateral market value
- 02Asset-specific threshold
- 03Weighted collateral
- 04Compare with debt
Read these as connected concepts, not necessarily consecutive steps.
Read the explanation
Loan-to-value limits new borrowing relative to eligible collateral. A liquidation threshold helps determine when a position becomes liquidatable. These parameters serve different purposes and can differ by asset. A portfolio with several collateral assets uses their respective values and thresholds, not a single arbitrary percentage applied to everything.
Put the mechanism into context
Use fictional collateral worth 1,000, an LTV of 60% and a liquidation threshold of 75%. Compare maximum initial borrowing with the threshold-weighted collateral value. Then examine a debt of 500 after a 20% collateral-price fall.
Apply it in the workshop →What this mechanism does not guarantee
Collateral value depends on oracle prices, while debt can change through interest or the borrowed asset’s price. Correlation can reduce some price mismatch but does not eliminate depegging or liquidity risk. Borrowing up to the maximum leaves less room for unfavorable changes than a position with a deliberate buffer.
The distinction that changes the analysis
In a fictional model, collateral worth 1,000 with a 70% borrowing limit allows 700 of initial borrowing. An 80% liquidation threshold is a different risk boundary. Never replace one percentage with the other merely because both apply to collateral value.
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
Use fictional collateral worth 1,000, an LTV of 60% and a liquidation threshold of 75%. Compare maximum initial borrowing with the threshold-weighted collateral value. Then examine a debt of 500 after a 20% collateral-price fall.
The initial limit is 600. After the fall, collateral is 800 and its threshold-weighted value is 600; divided by debt 500, health factor is 1.2. Being above 1 now does not prevent a later liquidation. Recalculate with debt interest or another price fall.
Terms in this lesson
- 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.