In this blog post, we’ll dive into one of the key parameters every borrower should look at in Nostra: the Health Factor.

Let’s jump right in!

Why is the Health Factor Important?

The Health Factor in DeFi is crucial for maintaining the safety of your loans and investments.

It acts as a traffic light, signalling how much the value of your collateral exceeds that of your debt. This balance is vital to prevent the risk of liquidation, where you could lose your collateral.

In Nostra, you can check the overall Health Factor of your account in the top right corner.

Health Factor and its Role in DeFi

One of the beauties of DeFi is the ability to borrow money permissionlessly.

No background checks, no FICO scores, no pay slips to provide to bank credit officers. Just connect your wallet to your favorite lending protocol (which we all know is Nostra) and you are good to go!

You can borrow on Nostra without having your creditworthiness checked, you just need to have an asset you can pledge as collateral.

However, by depositing an asset as collateral, you are willing to lose some or all of it under certain circumstances.

What circumstances, exactly?

When the value of your collateral comes too close to the value of your debt, Nostra can close (liquidate) your position and allow someone else (a liquidator) to pay the debt for you and keep your collateral in return.

As long as liquidators can collect collateral that is worth more than the debt they repay, everything works fine.

How do you, as a borrower, know when you risk being liquidated? The health factor is a metric that does just that: it tells how close your position is to being liquidated.

How Does the Health Factor Affect Your Strategies?

The Health Factor can be grossly thought of as the ratio between the dollar value of what you give to lenders as a guarantee (your collateral) and what you get from them (your debt).

Since the dollar value of your collateral must exceed that of your debt, you can see that the health factor should never fall below 1.

However, there are a few nuances to consider:

• The difference between the dollar value of your collateral and your debt must be sufficient to allow liquidators to achieve a profit even during distressed market conditions (e.g., when prices fluctuate very abruptly).
  You can think of it as a safety buffer that ensures your position can be comfortably liquidated.

• Not all assets are the same. Stablecoins, for instance, rarely move in price whereas assets like BTC or ETH could be extremely volatile. The more volatile an asset is, the higher the safety buffer must be. Read more about Nostra tokens.

These two considerations have led us to come up with two numbers that Nostra uses within the health factor calculation: the collateral and borrow factors.

Collateral Factor

The numbers, between 0 and 1, express how stable a certain asset can be if used as collateral (collateral factor) or debt (debt factor).

A collateral factor of 90%, for instance, means that the dollar value of such asset should be multiplied by 90% to obtain its “stable” worth.

The lower the collateral factor, the riskier an asset is if used as collateral.

Borrow Factor

The borrow factor works the same way but it divides, instead of multiplying, the dollar value of an asset used as debt. The lower the borrow factor, the riskier an asset is if borrowed.

Now we have all the elements to come up with the health factor formula:

The picture below shows the calculation of the health factor with a $ 150 collateral asset whose collateral factor is 90% and a $ 100 debt whose borrow factor is 80%

Putting the Health Factor in Practice:

Imagine you've borrowed BTC using a volatile asset like ETH as collateral.

If either the price of ETH falls rapidly or the price of BTC skyrockets (or both), your health factor will quickly start decreasing. This is your cue to act.

You can either add more ETH to bolster your collateral, thus maintaining a safe buffer, or repay part of your BTC loan to reduce your debt.

These proactive steps help prevent the risk of your assets being liquidated during market downturns.

By keeping a close eye on the health factor and understanding its implications, you can make informed decisions to protect your investments in Nostra's dynamic DeFi environment.

How Do You Keep Your Health Factor above 1?

• Collateral top-up: when your health factor is decreasing, consider depositing more collateral to increase the safety buffer

• Debt repayment: when your health factor is decreasing, consider repaying a portion of your outstanding debt to increase the safety buffer

• Asset choice: if you can choose among a pool of similar assets to either borrow or use as collateral, always go with the one with the highest collateral and/or borrow factor

Remember the old “health is wealth” adage. In DeFi, being “healthy” protects you from losing money due to sudden price moves that could cause the loss of your collateral.

The road to financial freedom is a marathon, not a sprint. Be smart, not greedy.

You can monitor your health factor in Nostra at any time to see exactly how it is moving and what you should do to keep it healthy.

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