A bank without a banker. One big shared pot: some people deposit into it, others borrow from it, and a program sets the interest rate automatically based on how full the pot is. The emptier the pot, the more borrowing costs. That is all that Aave, Morpho and Euler are.
A bank without a banker
No credit committee, no phone calls, no paperwork. Rates move by formula: high utilization of the pot pushes rates up to attract depositors and discourage borrowers, low utilization pulls them down. Everything else in this chapter follows from one constraint: the protocol has no idea who you are.
Why they ask for more than they lend you
The protocol cannot call you, sue you, or send a debt collector. So it demands a guarantee posted up front, and bigger than the loan. That guarantee is your collateral, and the loan is overcollateralized: deposit $1,000 of ETH, borrow at most about $800 of stablecoin against it.
Two numbers frame every position:
- LTV (loan to value): how much you can borrow at the start. 80% LTV on $1,000 deposited means $800 borrowable.
- Liquidation threshold: the point where you get seized. Often 82 to 85%.
The health factor, the most important number in your DeFi life
The health factor compresses your whole situation into a single number, and the reading is simple:
health factor = (collateral x liquidation threshold) / debt above 1 you are fine below 1 you are liquidatable, immediately
Worked example. You deposit $1,000 of ETH, the liquidation threshold is 82%, you borrow $500 of USDC:
(1000 x 0.82) / 500 = 1.64 you are comfortable ETH drops 30%, your collateral is worth 700: (700 x 0.82) / 500 = 1.15 getting tense ETH drops again, collateral 600: (600 x 0.82) / 500 = 0.98 liquidation
Liquidation is a bot repaying your debt for you and walking away with part of your collateral plus a 5 to 10% penalty. It is not negotiable and it happens in seconds. It is also the reason the most important alert Otomato sends exists: your health factor approaching 1 is exactly the kind of thing that moves while you sleep.
Looping, or how people actually get hurt
Deposit ETH, borrow stablecoin against it, buy more ETH with the loan, deposit that, borrow again. Four rounds later you are exposed to roughly three times your stake. That is looping, and it multiplies gains and losses alike. A looper's health factor lives permanently near the edge, which is why loop positions deserve their own, tighter monitoring.
The net APY trap, the silent one
You earn 4% on what you deposited and pay 7% on what you borrowed: your position loses money every single day, quietly, without ever tripping a risk alert. That is negative net APY. Nobody wakes you up for it, yet it is a position that needs fixing. Otomato flags it as suboptimized, a good example of monitoring that is about cost, not danger.
The two failure modes of a lending position