In Ethereum-based lending, liquidation is the process of reducing an undercollateralized loan: a third party repays some or all of a borrower’s debt and receives collateral under the protocol’s rules. For Aave V3, a health factor below 1 makes a position eligible, but eligibility does not automatically seize collateral. A liquidator must submit a transaction, and the amount repaid and collateral taken depend on the protocol, version, market and active risk parameters.
What liquidation means in Ethereum lending
This explanation concerns collateralized borrowing in decentralized finance (DeFi), where a borrower deposits assets and borrows against them. It is not a description of every kind of leveraged Ethereum trade: derivatives and other products can use different margin and liquidation mechanisms.
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A lending protocol needs a way to respond when collateral no longer satisfies its borrowing rules. Liquidation is that response. A liquidator repays debt on behalf of the borrower and receives some of the borrower’s collateral, generally at a discount or with a bonus that incentivizes the transaction. The repayment reduces the debt; the collateral transfer reduces what the borrower owns in the protocol.
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Repair common Windows errors and clear accumulated junk for a smoother, more stable PC - no reinstall needed.Free scan · no reinstallThe protocol sets the eligibility rules, but a third party initiates the transaction. Aave describes liquidations as permissionless: any network participant can initiate one when a position is eligible. That does not mean every eligible position is seized instantly. A transaction has to be submitted and successfully executed on the network.
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How Aave V3 determines whether a position is eligible
The health-factor calculation
Aave V3 uses a health factor to express how much collateral value a position has relative to its debt and the liquidation thresholds of its collateral assets. Aave gives the formula as:
Health Factor = (Total Collateral Value × Weighted Average Liquidation Threshold) ÷ Total Borrow Value.
A health factor below 1 means the position is eligible for liquidation under Aave V3. The liquidation threshold is specific to each collateral asset and set through Aave governance. The calculation therefore depends not only on the amount of collateral, but also on its value, the amount and value of the debt, and the applicable threshold.
A worked example
Aave’s help page illustrates the calculation with $10,000 of ETH collateral at an 80% liquidation threshold and $6,000 borrowed. The calculation is ($10,000 × 0.80) ÷ $6,000, producing a health factor of 1.333. This is an illustration of the formula, not a recommended borrowing level or a universal safe threshold.
A health factor can decline if collateral loses value, the borrowed asset becomes more valuable relative to the collateral, or interest accrual increases the debt. Aave V3 documentation also explains that prices from oracles and accrued interest affect the factor. The risk can therefore change even if a borrower does not take another action.
Why a factor just above 1 is not a guarantee
A value above 1 means the position is not below Aave V3’s stated eligibility threshold at that moment; it does not guarantee that it will remain there. Market prices, debt accrual and transaction conditions can change. Aave cautions that there is no single universally safe health-factor target because volatility and the relationship between collateral and debt assets differ.
What happens when a position is liquidated
- The position becomes eligible. For Aave V3, the health factor falls below 1 under the applicable market parameters.
- A liquidator submits a transaction. The liquidator calls Aave V3’s
liquidationCallfunction, selecting debt to repay and collateral to receive. - Debt is repaid. The liquidator repays some or, where the rules permit, all of the borrower’s selected debt.
- Collateral is transferred. The liquidator receives a proportional amount of the selected collateral at a discount that includes the liquidation bonus. Aave V3 may deliver the underlying collateral token or its aToken equivalent.
- The borrower’s position changes. The debt falls, and the collateral balance falls. A partial liquidation can leave a smaller position open; depending on eligibility and the applicable rules, a larger or full liquidation may occur.
The borrower should not assume that only a small portion will be taken or that the collateral left behind will be enough to continue the original strategy. The result depends on the protocol’s close-factor rules and position conditions, not simply on the borrower’s expectation of a partial repayment.
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Who funds the repayment?
Liquidators are specialized third parties and commonly use automated bots to identify and execute opportunities. The Bank of Canada’s 2025 staff paper describes liquidators using flash loans in some transactions. A flash loan lets a liquidator borrow funds and repay them within the same transaction; if repayment cannot be completed, the transaction does not complete. This can provide transaction funding without requiring the liquidator to hold the full repayment amount beforehand.
Liquidation execution is competitive. Being eligible does not ensure that a particular liquidator’s transaction will succeed: it must be submitted and executed under the network and protocol conditions at that time.
Aave V3 close factors and small-position rules
Aave’s current help page describes these V3 liquidation limits. They are Aave guidance figures, not universal Ethereum rules, and may change as protocol parameters or guidance change.
| Position condition described by Aave | Liquidation amount described |
|---|---|
| Health factor above 0.95, with collateral and debt each at least $2,000 | Up to 50% of the debt can be liquidated |
| Health factor at or below 0.95, or collateral or debt below $2,000 | Up to 100% of the debt can be eligible for liquidation |
| A partial liquidation would leave less than $1,000 of debt or collateral | The position must be fully cleared rather than left below that minimum |
These dollar values and close-factor conditions are specific to the Aave help-page guidance referenced here; they should not be applied to a different protocol, market or version without checking its active rules. They also show why “liquidation is always 50%” is not a reliable assumption. In the stated conditions, up to the full debt can be eligible, and a partial liquidation cannot necessarily leave a very small remainder.
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Aave V3, Aave V4 and other protocols are not interchangeable
There is no single Ethereum-wide liquidation procedure. Protocol design, version, asset, market and governance parameters all matter. For example, the OECD describes Maker’s auction-based collateral sales, in contrast to instant liquidation mechanisms with predetermined incentives used by Aave and Compound. A borrower needs the rules for the specific position, rather than a generic description of “Ethereum liquidation.”
| Protocol or version | Mechanism established by the cited descriptions | What not to assume |
|---|---|---|
| Aave V3 | Health-factor eligibility, close-factor rules and a liquidation bonus; a liquidator repays debt and receives selected collateral. | Do not apply V4’s target-health-factor calculation to a V3 position. |
| Aave V4 on Ethereum mainnet | Launched on 30 March 2026, according to Aave. Its Hub and Spoke architecture has three liquidity hubs and spokes with their own collateral types, risk parameters and liquidation rules. The V4 liquidation engine describes calculating repayment to bring a borrower to a governance-set Target Health Factor, with the bonus varying according to health factor. | Do not treat V4’s target-health-factor design as the V3 rule, or assume every V4 spoke has identical parameters. |
| Maker | The OECD describes an auction-based collateral-sale mechanism. | Do not describe Maker’s auction process as an instant liquidation with Aave’s rules. |
| Compound | The OECD describes an instant liquidation mechanism with predetermined incentives. | Do not assume its thresholds, repayment limits or incentives match Aave’s. |
Aave Labs reported that Aave V4 surpassed $1 billion in deposits during September 2026. That is a deposit figure reported by Aave Labs, not the value or number of liquidations. It does not measure liquidation activity across Ethereum.
Can a borrower lose all their collateral?
It depends on the protocol and position. A partial liquidation can leave collateral and debt in place, but Aave V3’s stated conditions allow up to 100% of debt to be eligible in some cases. Its small-position rule also requires a position to be fully cleared if a partial liquidation would leave less than $1,000 of either debt or collateral. These rules do not support a blanket promise that a borrower will always retain collateral after liquidation.
Even where a liquidation is partial, the remaining position may no longer suit the borrower’s plan. It could have less collateral, less borrowing capacity or a different risk balance. The exact outcome is governed by the relevant market and its parameters; the mechanism is not a negotiated repayment plan with the borrower.
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Aave says that adding collateral or repaying some debt can improve a position’s health factor. Those actions address the ratio directly: more eligible collateral can raise the numerator, while less debt can reduce the denominator. Whether an action is timely or sufficient depends on current prices, accrued interest, asset thresholds and transaction execution.
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- Identify the exact protocol, version and market. Confirm whether the position is on Aave V3, Aave V4 or another protocol, and check the rules for the specific market and collateral assets.
- Review the position’s health factor and inputs. Check collateral and borrowed-asset values, the thresholds applied to collateral, and whether debt accrual or price movements have changed the calculation.
- Choose an action that addresses the exposure. Adding collateral or repaying debt can improve Aave’s health factor. Consider how the selected action affects the position as a whole rather than relying on a single reading.
- Allow for changing conditions and execution. A displayed value can change as prices and debt change; submitting a transaction does not remove network and execution risks.
- Verify any automation or simulation yourself. Aave’s help page points to a health-factor simulator and lists DeFi Saver as an auto-repay tool. These are optional services, not guarantees against liquidation; users should verify current features and understand transaction and execution risks.
A health-factor reading is a snapshot of a changing position, not a promise about what will happen next. Aave’s warning that there is no universal safe target matters in practice: a volatile collateral asset or a weak correlation between collateral and debt can change risk differently from another asset pairing.
Why liquidations can matter beyond one borrower
Liquidation is intended to address undercollateralized loans, but selling seized collateral can also put pressure on its market price. Authors Alfred Lehar and Christine A. Parlour, in a BIS working paper, report temporary and permanent price impacts from collateral sales associated with liquidations. They describe a feedback loop in which sales can contribute to price pressure, which may in turn contribute to further liquidations.
A 2026 Bank of Canada staff analytical paper reports that Aave V3 liquidation events tend to occur in concentrated bursts rather than evenly over time. Concentration and feedback effects are reasons to take liquidation risk seriously, but they do not mean every liquidation causes a market-wide cascade. The outcome depends on market conditions and the scale and timing of sales.
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Key distinctions to remember
- Eligibility is not execution: an eligible position still requires a liquidator’s successful transaction.
- Liquidation reduces both sides of the position: debt is repaid, and collateral is transferred according to protocol rules.
- One protocol’s rules are not Ethereum-wide rules: triggers, close factors, bonuses, auctions and minimum remaining amounts vary.
- Version matters: Aave V3’s health-factor and close-factor mechanics should not be confused with Aave V4’s described Target Health Factor approach.
- Deposits are not liquidations: Aave Labs’ reported $1 billion in V4 deposits in September 2026 is not a liquidation-volume statistic.
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