FOLLOW THE MECHANISM
- 1Pledge
Eligible assets become collateral.
- 2Receive
- 3Revalue
Prices and interest change the position’s health.
- 4Repay
Returning debt assets frees collateral under the rules.
A conceptual sequence. Real implementations can add steps, intermediaries, and conditions.
The asset and debt move in opposite directions
A collateralized borrower locks or designates eligible assets and receives another asset to use. The original collateral remains exposed to its own price changes, while a debt balance grows under the lending rules. Receiving borrowed tokens is not investment income: an offsetting obligation appears at the same time. Repayment usually requires the borrowed asset or a supported repayment mechanism. A debt denominated in a volatile token can become more expensive in the borrower’s preferred currency.
Entry limits and liquidation limits differ
Loan-to-value limits restrict how much new borrowing a collateral amount supports. Liquidation thresholds determine when an existing position becomes eligible for forced debt repayment using collateral. They are distinct parameters and can differ by asset, market and mode. A position may be unable to borrow more while still remaining above its liquidation boundary. Conversely, price changes or accumulated interest can move an existing loan toward liquidation even if no new tokens are borrowed.
Track value, quantity and price separately
For a one-collateral educational model, collateral value is quantity multiplied by oracle price, debt value is owed units multiplied by the debt-asset price, and health factor is collateral value times liquidation threshold divided by debt value. With no debt, that ratio is not a meaningful finite number; the position has no debt-driven liquidation exposure in this model. Multiple collateral assets require weighted thresholds. These calculations are accounting relationships, not a safety recommendation or reproduction of every Aave feature.
Closing the position is another transaction path
To close a loan, debt must be repaid including accrued interest before all pledged collateral can generally be released. A swap used to acquire repayment assets can incur fees and price impact. Network congestion, outages and oracle changes can interfere with an intended adjustment. Some modes constrain which assets can be borrowed or how exposure is isolated. The demonstration keeps one collateral and one debt asset so the causal relationships are visible, while actual contracts can impose additional caps, rounding and permissions.
MAKE IT CONCRETE
Illustrative health calculation
Collateral worth 1,000 reference units with an 80% liquidation threshold and 500 of debt has health factor 1.6. If collateral falls to 600, health falls to 0.96 even though debt units have not changed.
FAILURE PATHS & COMMON MISREADINGS
Where the model can break
- Borrow capacity is different from the liquidation boundary.
- Borrowed funds are accompanied by a debt, not free capital.
KEEP EXPLORING