Free lesson · DeFi models

Collateral health factor and correlated shocks

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A lending position is protected by collateral only to the extent its discounted value covers the debt under the protocol’s valuation rules.

For multiple collateral assets, sum value times each liquidation threshold and divide by debt value. A health factor of one is a modeled boundary, not a safe target.

Use the oracle’s valuation convention and current debt units. Collateral falling while borrowed stablecoin rises is a joint adverse scenario. Interest accrual and changes to eligibility can erode health without a new trade.

Apply it in a strategy

• Build a collateral stress matrix with oracle timing, accrued debt and withdrawal restrictions.
• Record the input timestamp, executable quantity, currency and horizon. Reconcile the result with a cash-flow or state table.
• Stress this failure condition: An apparently healthy stale oracle can conceal an economically insolvent position.

Research deliverable

Build and explain a collateral health factor and correlated shocks worksheet. Build a collateral stress matrix with oracle timing, accrued debt and withdrawal restrictions.

Evidence boundary: Synthetic arithmetic and scenarios illustrate mechanics. They are not historical returns, a paper replication, or evidence of an executable edge. Research sources and their access limitations are recorded at the end of this module.

# Python 3.10+; standard library unless NumPy is imported below.
# Inputs and outputs use the units defined in this lesson. Synthetic teaching example.
def health_factor(values,thresholds,debt):
    if debt<=0 or len(values)!=len(thresholds) or any(v<0 for v in values) or any(not 0<=t<=1 for t in thresholds): raise ValueError("Invalid health inputs")
    return sum(v*t for v,t in zip(values,thresholds))/debt

print(health_factor([12000],[.8],8000),health_factor([9600],[.8],8000))