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Safeguarding collateral and mitigating liquidation risks
- A Health Factor of ≤1 is considered unviable and subject to liquidation by the protocol.
- A Health Factor of 2 means that 1/2 = 50% more borrowing can be done, or a 50% price drop in the collateral’s relative value can be sustained, before liquidation.
Mathematically, a position’s health factor = 1 when
sum(CollateralLiqThreshold x CollateralAmount x CollateralValue) = sum(LoanAmount x LoanValue)
It's important to monitor your Health Factor and keep it high to avoid liquidation. Keeping your Health Factor over 2, for example, gives you more of a margin to avoid a liquidation.
Users can raise their Health Factor by depositing more collateral assets or repaying part of their loan. By default, repayments increase your health factor more than deposits.
The price fluctuations of stablecoins, like any assets, affects Health Factor; One should be mindful of the stablecoin price fluctuations due to market conditions and how it might affect one's Health Factor. For example, a market price of 1 USDC might not be exactly equal to 1 USD, but instead (e.g.) 0.95 USD.
What happens when my Health Factor is reduced? Depending on the value fluctuation of your deposits, the health factor will increase or decrease: A) If your Health Factor increases, it will improve your borrow position by making the liquidation threshold more unlikely to be reached. B) If the value of your collateralized assets decreases against the borrowed assets, the Health Factor will also be reduced, increasing the risk of liquidation.