DeFi and Market Structure · Crypto Trading Guide

Borrowing against crypto creates a liability that can grow while collateral falls. Monitor the complete position rather than the advertised borrowing rate.

Separate supply from borrowing

A lending protocol can allow eligible supplied assets to support borrowing. The borrowed asset is a liability, not additional wealth. Protocols specify collateral factors, caps, liquidation thresholds and price oracles. These settings differ by market and can change through governance or risk controls.

Calculate health factor

In a simplified example, collateral is worth $12,000, the applicable liquidation threshold is 80% and debt is $6,000. Health factor is $12,000 × 0.80 ÷ $6,000 = 1.6. Under an Aave style framework, falling below 1 makes a position eligible for liquidation. This is an educational example, not a current parameter quote or a universal lending rule.

Shock both sides

If collateral falls 30% to $8,400 while debt stays $6,000, health factor becomes 1.12. If interest or the debt asset’s price then raises the debt value to $6,800, the factor becomes about 0.988. A position can deteriorate because the liability rises as well as because collateral falls. Stablecoins also need price scenarios.

Plan liquidity before stress

Repaying debt or adding eligible collateral can improve the metric, but network congestion, wallet access and available funds determine whether action is possible in time. Liquidation can transfer collateral at a penalty under protocol rules. Recursive borrowing creates several linked exposures rather than free yield. Review oracle behaviour, collateral concentration, contract risk and governance powers. A high current health factor is a snapshot, not a permanent safety certificate. Keep a route to repay that does not depend entirely on selling the same falling collateral.

Try it yourself

Collateral is $5,000, threshold 75% and debt $3,000. What is health factor, and what if collateral falls 20%?

Show the worked answer

It starts at 1.25. After collateral falls to $4,000, it is 1.00 before interest and other changes, leaving no buffer to that threshold.

Further reading

Educational material. Examples and rates are hypothetical, not trade recommendations. Product terms, eligibility and risks vary by venue and jurisdiction.

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