Lending markets: utilization, LTV, liquidation
How a collateralized lending market computes — and at which three points it breaks.
This lesson has had no expert review. It was written for this platform and against the evidence it cites; nobody has gone through it independently.
Learning objectives
- You can tell utilization, LTV and health factor apart and compute them.
- You can explain how market risk becomes credit risk.
Check your prior knowledge
Answer these for yourself before reading on. Wherever you hesitate is where this lesson pays off.
- Why does a protocol require more collateral than it lends?
- Who buys the collateral in a liquidation?
- What happens if nobody buys?
Core concept
Utilization drives the rate — and caps withdrawals
The rate in a lending market is a function of utilization: the more of the supplied capital is lent out, the more expensive the loan and the more reaches the depositor. The same number also describes how little free capital is left. A market at 95 % utilization pays well and may no longer let a large depositor out.
The health factor is the distance to forced sale
Instead of the borrower's creditworthiness, what counts is the value of their collateral. If it falls far enough that the position drops below the threshold, anyone may realize it at a discount. That is not an exception but the built-in mechanism keeping the market solvent — and it acts automatically, with no grace period and no conversation.
Bad debt arises when the mechanism acts too late
Liquidation presupposes someone buys — fast enough and at a price covering the loan. If the collateral falls faster than liquidation can happen, or the market is too thin, an uncovered claim is left behind. Who bears it is the protocol's decision: the reserve, the depositors or the token holders. That question rarely appears in the product description.
Definitions
- Utilization
- Share of supplied capital that is borrowed.
- Health factor
- Ratio of weighted collateral value to outstanding loan; below 1 the position is liquidatable.
- Max LTV in the glossary
- Highest share of collateral value that may be borrowed against.
Model
Collateral price falls
Oracle writes the new price into the contract
Health factor drops below 1 — the position becomes liquidatable
Realization at a discount, selling pressure in the market
If proceeds fall short: bad debt, allocated by the protocol's rule
Formulas
Utilization
Utilization = borrowed / supplied- borrowed
- sum of outstanding loans
- supplied
- sum of supplied capital
Limit: The figure says nothing about distribution: the same utilization can arise from many small loans or from two large ones, with very different liquidation dynamics.
Health factor
HF = (collateral value × liquidation threshold) / loan value- collateral value
- current value per the oracle
- liquidation threshold
- a market parameter, typically below 1
- loan value
- outstanding loan including accrued interest
Limit: The value depends entirely on the oracle price, not the market price. Where the two diverge, the position is exposed to the oracle, not to the market.
Worked example
How far may the price fall?
- Collateral
- 10 ETH at USD 2,000 = USD 20,000
- Loan
- USD 10,000
- Liquidation threshold
- 0.80
HF = (20,000 × 0.80) / 10,000 = 1.6. HF = 1 is reached at a collateral value of 10,000 / 0.80 = USD 12,500, i.e. USD 1,250 per ETH.
Buffer to liquidation: a 37.5 % price decline.
Reading: The buffer is a price distance, not time. How long it lasts depends on the collateral's volatility — and on whether the oracle reflects the fall promptly at all.
Interactive model
The worked example, with movable figures. Estimate first what happens — then check.
Health factor and liquidation price
Move the collateral price and watch the distance to the HF = 1 threshold.
Estimate first, then check
Estimate first: at what ETH price does the example's position reach a health factor of 1? And what happens to the buffer if the liquidation threshold drops from 0.80 to 0.70?
The starting values are the worked example's own figures — change one input at a time.
Health factor: 1.6. Price at HF = 1: $1,250. above the threshold — not liquidatable.
What the model does not show: The loan value stays constant here. In practice interest accrues, and the price the model moves is the oracle price — not the market price at which a liquidation is then executed.
Retrieval
Exercise on real data
Open a lending market and note utilization and maximum LTV. Work out what collateral price decline would reach the threshold.
Look at a lending market's utilization and LTV →Application
Which three metrics do you monitor continuously when your organization supplies capital to a lending market — and at what value do you act?
Related case studies
Institutional reading
- Bank
- How should the possibility of constrained withdrawals be reflected in the liquidity risk report?
- Insurance
- Would bad debt be an insured event or a market loss?
- Asset management
- At what utilization is the position reduced — and who decides that?
Metrics in this lesson
Key takeaways
- High utilization means a high rate and little free capital — the same fact from two sides.
- The health factor depends on the oracle price, not the market price.
- Who bears bad debt is a protocol decision and rarely appears in the product description.
Evidence
- EVD-2026-0008
DeFiLlama — DeFiLlama yields endpoint (/pools)