In this article I will give some examples on LTV (Loan To Value) explaining how Lending platforms (Money Market) work. A Lender deposits liquidity and obtains an interest (APY) which is paid by the Borrower who requests a loan (those who ask for a loan will then have to repay it with interest, this gain is shared between the Lender and the platform). The interest rate for depositors increases as the demand for that asset increases. Conversely, if everyone deposits an asset and no one borrows it (low demand), the interest rate for the liquidity provider of that asset...goes down. A Money Market must always have liquidity available (ie a reserve that allows the Lender to withdraw at any time), in this regard each platform has a certain % saturation. Beyond this threshold, the interest to apply for a loan becomes very high and in the same way the APY for those who provide liquidity becomes very high: this serves to encourage deposits and reduce loans (because it costs more to repay them). As the utilization rate of an asset increases, the Borrow APY increases. Obviously these incentives work if the platform is liquid (if there is little liquidity you have to be careful).
WHY ASK FOR LOANS?
If you are holding ETH, perhaps you need liquidity and don't want to sell ETH. I block my ETH as collateral and take out a loan (usually in stablecoins that I can rent or use to buy something else or get out into fiat; loans are not taxable events). Otherwise I could also block ETH (or wBTC), take stable and buy more ETH (or wBTC): leveraged exposure. Basically if 1 ETH is worth $1000 I cannot borrow $1000 because otherwise my loan could become under-collateralized in a short time (if ETH goes down in price). If ETH drops to $900 and I have borrowed $1000 I may no longer be willing to repay the loan, for this reason I can borrow for example 2/3 of the collateral (i.e. block $1000 and borrow 660) .
There are usually two Borrow strategies:
1) I lock up a volatile token and borrow a stablecoin (I get liquidated if my collateral drops in price)
2) I block a stablecoin and borrow a volatile token (in this case I get liquidated if the borrowed amount rises too much in price)
The LTV tells us the maximum amount I can borrow, beyond which I could be liquidated (usually the maximum LTV is a % lower than the liquidation). Each collateral must not be less than the dollar value of the loans given otherwise the platform would have "bad debit" (insolvency/default). No borrower should be insolvent, liquidation occurs when collateral falls too low.
The Loan To Value (LTV) is therefore my maximum borrowing power after depositing a specific guarantee. "Value" refers to my deposit. When I ask for a loan, I'm going to deposit a guarantee X. I can borrow a dollar value of this guarantee obviously lower than the amount deposited. For example, if a collateral has a 60% LTV, you can borrow up to 0.60 ETH (in dollars) for every ETH deposited.
If 1 ETH=1000$ I can borrow a maximum of 600 USDC (600$). Usually the maximum LTV is below the liquidation threshold. If we assume liquidation is 60% and you can borrow 60%, you would be liquidated when the LTV slightly exceeds 60% (a few dollars decrease in collateral would suffice!). Instead I have no problems if LTV stays below this percentage. From this speech it can be seen that if the liquidation threshold is set at 70%, I should be able to borrow a maximum of 60 or 65% as max LTV (for a security issue I could borrow 50% or even less).
LTV is therefore the ratio of "borrowed value" / "deposit". If I borrowed $400 and deposited $1,000, I have debt equal to $400/$1,000=0.4 times 100=40%.
If my max LTV is 60% I can borrow up to $600, ie $600/$1000=0.6 times 100=60%.
As you can see, if max LTV equals liquidation and I have a max LTV of 60%, I could borrow $600 of the $1000 deposited but if my collateral drops to $999 (my collateral deposit is still 1 ETH but it is falling in price), I would have $600/$999=0.60061 times 100=60.061% (i.e. having exceeded 60%, my assets would go into liquidation because they are under-collateralized and I would lose part of them or the loan would closed + a liquidation fee). When a liquidation occurs, liquidators repay some or all of the loan amount on behalf of the borrower. In return, they can purchase the guarantee at a discount and keep the difference as a bonus.
In summary, if I have a collateral factor (liquidation) of 70% on the deposited amount, I should be able to borrow at most 60% (LTV max) of my deposited amount. However, to be even safer, I can "only" borrow 55 or 50% and not 60% (I have less borrowing power than the maximum LTV). These % are variable, depending on the platform. If the loan I took out is worth 70% of my collateral I am liquidated (the loan is closed, my collateral is sold at a discount + liquidation fee).
HEALTH FACTOR
Some protocols use the "Health Factor" which indicates how "safe" your loan is, calculated as the proportion of collateral deposited to the amount borrowed (ratio of current LTV to liquidation LTV). Liquidation is avoided if this factor is greater than 1.
There are protocols such as Synthetix Network that automatically open debts when staking the native token of the platform (SNX) but in this case we are talking about "C-Ratio", i.e. a collateralisation ratio ideally set at 400%. In this case, for every $400 you deposit as SNX you get 1/4 loaned out (basically you get 100 sUSD which is worth $100). If I deposit $1000, I will borrow $250 sUSD (that's 25% of my collateral).
The flag with part of the liquidated assets (penalty) in this case comes when the C-Ratio drops to 145% (clearly adding more collateral, in this case SNX or burning the borrowed USD brings you back towards 400%). The liquidation threshold at Synthetix is 69%.
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