Collateral, LTV and Borrowing Power

In a bank, “how much can I borrow?” is answered by a credit score, a salary slip, and a loan officer who may or may not have had coffee. In DeFi there is no officer and no coffee. The contract doesn’t care who you are — it only cares about one number: how much can this collateral support? That number falls out of a few cold ratios. Learn the ratios and you can predict, to the dollar, what the protocol will let you do before you click anything.

Collateral: skin in the game

Analogy. Collateral is the deposit you leave at a ski-rental shop: you still own your driving licence sitting in their drawer, but you don’t get to walk off with it until you bring the skis back. The shop holds it precisely so that “default” has a cost.

Definition. Collateral is an asset you lock into the lending contract to back a loan. Three things stay true while it’s locked: it remains yours (you keep the upside and downside of its price), it stays escrowed by the contract (you can’t spend it), and it can be seized and sold if your loan goes bad. That last clause is the whole point — it’s what lets a stranger lend to you with zero trust.

Worked example. You deposit 5 ETH at $2,000 each. Your collateral value is $5 \times 2{,}000 = 10{,}000$ dollars. If ETH rallies to $2,400, your collateral is now worth $12,000 — you captured the gain even though the tokens are locked. The contract just holds them; it doesn’t freeze their market exposure.

Loan-to-Value (LTV)

Analogy. LTV is the “how leveraged am I?” dial. Zero means you’ve borrowed nothing against a big pile of collateral; the higher it climbs, the closer your debt creeps to the value backing it.

Definition. Loan-to-Value is the ratio of what you owe to what you’ve put up:

$\text{LTV} = \frac{\text{debt value}}{\text{collateral value}}$

It’s a snapshot that moves whenever either number moves — borrow more and it rises; your collateral’s price drops and it also rises (same debt, smaller denominator).

Worked example. You borrow $6,000 against $10,000 of collateral:

$\text{LTV} = \frac{6{,}000}{10{,}000} = 0.60 = 60\%.$

Sixty cents of debt for every dollar of collateral.

Max LTV / collateral factor

Analogy. Think of each asset as a different lending desk with its own house rules. Boring, stable assets get a generous desk; jumpy, illiquid ones get a stingy one. The protocol won’t let your initial LTV exceed that desk’s limit.

Definition. Max LTV (also called the collateral factor, or borrow factor) is the highest LTV the protocol allows at the moment you borrow, set per asset. Calm, deep, liquid assets get a high max LTV; volatile or thinly-traded ones get a low one. The logic is risk: if an asset can crash 30% before the protocol can sell it, the protocol must lend against it conservatively so the sale still covers the debt. Stablecoins, which barely move, get the highest factors of all.

Worked example. You lock 10 ETH at $2,000 → collateral value $20,000. ETH’s max LTV is 75% on this market, so your borrow ceiling is:

$20{,}000 \times 0.75 = 15{,}000 \text{ dollars}.$

You may borrow up to $15,000 — not a cent more in the same transaction.

Borrowing power and “still available”

Analogy. Borrowing power is the size of your bucket; your current debt is the water already in it. Available is how much room is left before it overflows.

Definitions.

$\text{borrowing power} = \text{collateral value} \times \text{max LTV}$ $\text{available to borrow} = \text{borrowing power} - \text{current debt}$

Worked example. Collateral $20,000, max LTV 75% → borrowing power $15,000. You’ve already drawn $9,000. Then available $= 15{,}000 - 9{,}000 = 6{,}000$ dollars. Borrow that and you’re at the ceiling with $0 of headroom — technically allowed, spectacularly fragile.

Drag the sliders below. The lower line is your Max-LTV borrow limit; the higher line is the liquidation threshold. Keep your borrow bar left of both.

Max LTV vs liquidation threshold

This is the pair that trips everyone up, so read it twice. There are two lines, not one:

• Max LTV — the gate at borrow time. You can only open or grow a loan while your LTV stays at or below it (say, 75%).
• Liquidation threshold — the danger line. You are only liquidated once your LTV crosses this higher number (say, 80%).

The gap between them is your safety buffer. It exists so that a tiny price wiggle in the minutes after you borrow doesn’t instantly trigger liquidation. You’re stopped from borrowing at 75% precisely so you don’t begin life one breath away from 80%.

Worked example. Collateral $20,000, max LTV 75%, liquidation threshold 80%.

If you borrow the full $15,000, you sit $1,000 of debt-room below the liquidation line. The buffer is real money: it’s the cushion absorbing the next small move before things get ugly.

How prices move you across the lines

Here’s the quiet danger: you don’t have to do anything to drift toward liquidation. Hold the debt fixed and let the collateral price slide — the denominator of LTV shrinks and the ratio climbs all by itself.

Scenario. You borrowed $15,000 against 10 ETH at $2,000 (collateral $20,000, LTV 75%). ETH dips to $1,875:

$\text{collateral} = 10 \times 1{,}875 = 18{,}750, \qquad \text{LTV} = \frac{15{,}000}{18{,}750} = 80\%.$

A 6.25% price drop with zero new borrowing walked you straight onto the 80% liquidation threshold. That sensitivity — exactly how far the price can fall before you’re toast — is the health factor, and it gets its own lesson. The mechanics of who sells your collateral and at what discount is liquidation, also coming up.

Key Takeaways

Next up: those caps and buffers are only half the story — the cost of borrowing changes minute to minute. Lesson 3 cracks open DeFi’s interest-rate models and the utilization curve that sets your APR.