Greetings Aave Community,
This post provides an overview of the new liquidation mechanism in Aave V4. The changes are intended to create a more efficient and fair liquidation process to the benefit of users and Aave as whole.
The new liquidation engine is a critical component of Aave V4, and we are pleased to share the details with the community.
Aave V3 Liquidations
In V3, when a borrower’s health factor drops below 1, a liquidator can repay a portion of the borrower’s debt and claim a portion of their collateral as a reward. The amount a liquidator can repay is determined by a fixed close factor.
This means that liquidators always repay a fixed close factor percentage of the borrower’s debt and seize a corresponding amount of collateral, receiving a static liquidation bonus in the process. The default close factor is 50%, but this extends to 100% under certain conditions, such as when the health factor falls below 0.95 or when dust collateral or debt is involved.
This system is straightforward and effective at protecting the protocol from bad debt. But it has limitations. The fixed close factor means that borrowers are often over-liquidated. Even if a small repayment would be enough to restore a healthy position, the liquidator still has to repay a fixed amount of the debt. The static bonus also does not reflect the true risk of a position. Liquidators receive the same bonus percentage regardless of how far underwater a position is, which means there is no extra incentive to act quickly on the riskiest positions.
The Aave V4 Liquidation Engine
In V4, liquidations work differently. Instead of repaying a fixed percentage of the debt, liquidators can repay at most enough to return the borrower’s health factor to a specific level called the Target Health Factor. This target is set by governance for each Spoke and gives the protocol more control over how liquidations are handled.
When a liquidation occurs, the protocol calculates how much debt needs to be repaid to bring the borrower back to the Target Health Factor. In typical cases, the liquidator repays only up to that amount, not a fixed close factor. This means borrowers are not over-liquidated, and liquidators can act more efficiently.
V4 also introduces a variable liquidation bonus. The bonus paid to liquidators changes based on the borrower’s health factor. The lower the health factor, the higher the bonus. This creates a Dutch-auction-style system where the relative reward for liquidation increases as the risk to the protocol increases. Liquidators are incentivized to act quickly on the riskiest positions, which improves the overall health of the protocol.
Behind the scenes, the protocol uses several parameters to manage this process. The maxLiquidationBonus sets the maximum bonus a liquidator can receive for a given collateral type. The healthFactorForMaxBonus defines the health factor below which the maximum bonus applies. And the liquidationBonusFactor determines the minimum bonus at the liquidation threshold. These parameters define the relationship between health factor and bonus, allowing governance to fine-tune the system.
Handling Dust Debt
One of the challenges in any liquidation system is dealing with dust debt, or small leftover debt positions that are not economically viable to liquidate. In V3, there is complex logic governing the handling of dust, dependent on thresholds both for the amounts before and after a liquidation. This prevents dust, but it also creates situations where positions cannot be fully liquidated in one go.
V4 takes a different approach. If the debt or collateral remaining after a standard liquidation would be below the DUST_LIQUIDATION_THRESHOLD (e.g. $1,000), and the liquidator indicates they want to repay the entire position, the protocol dynamically adjusts the maximum amount of debt that can be liquidated. This requires the liquidator to fully clear the position, preventing dust from accumulating.
Parameters and Configuration
Aave V4 exposes several configurable parameters that influence liquidation:
| Parameter | Description | Constraints |
|---|---|---|
| TargetHealthFactor | A spoke‑wide value set by governance representing the HF to which a borrower should be restored after liquidation. Liquidators repay only enough debt to reach this HF under normal circumstances that do not result in dust collateral or debt remaining. | Must be ≥ the HEALTH_FACTOR_LIQUIDATION_THRESHOLD constant. |
| DUST_LIQUIDATION_THRESHOLD | Hard‑coded threshold used to prevent extremely small leftover debt. The maximum debt that can be liquidated is increased to ensure that debt or collateral dust less than this threshold does not remain unless the corresponding respective collateral or debt reserve is fully liquidated. | Hard‑coded constant set to 1000 USD in base units. |
| maxLiquidationBonus | Per reserve defined maximum liquidation bonus for a collateral, expressed in basis points (BPS). A value of 105 00 (105%) means there is 5% extra seized collateral over the amount of debt repaid in base currency. | Must be ≥ 100 00. |
| healthFactorForMaxBonus | Spoke‑wide value expressed in WAD units defining the HF below which the max bonus applies. It must be less than or equal to HEALTH_FACTOR_LIQUIDATION_THRESHOLD to avoid division‑by‑zero. | healthFactorForMaxBonus < HEALTH_FACTOR_LIQUIDATION_THRESHOLD. |
| liquidationBonusFactor | Spoke‑wide percentage (expressed in BPS) specifying the fraction of the max bonus earned at the threshold HEALTH_FACTOR_LIQUIDATION_THRESHOLD. It defines the minimum bonus; e.g., a factor of 80 00 yields a bonus equal to 80 % of the max bonus when HF equals the liquidation threshold. | liquidationBonusFactor must be <= 100 00 |
A Side by Side Overview
Ultimately, the changes in V4 create a more refined and efficient liquidation process. In V3, the repayment amount is fixed at 50% of the debt in most cases. In V4, the repayment amount is variable and calculated to bring the borrower back to the Target Health Factor set by governance. This means only the necessary debt is repaid, preventing over-liquidation.
The liquidation bonus also works differently between the two versions. In V3, the bonus is static and does not change based on the borrower’s health factor and instead requires a governance decision. In V4, the bonus is variable and increases as the health factor decreases, creating better incentives for liquidators to act on riskier positions.
Why This Matters
The new liquidation engine in Aave V4 makes the protocol more competitive and user-friendly. The adaptive repayment amount means borrowers are not over-liquidated. If only a small amount of debt needs to be repaid to restore a healthy position, that is all the liquidator is allowed to repay. This is fairer to borrowers and more capital-efficient.
These changes result in a more precise and capital-efficient liquidation process that better protects the protocol from bad debt while improving the experience for both borrowers and liquidators. The system is more flexible, more fair, and better aligned with the true risk of each position. Given the scale of liquidations on Aave, with up to hundreds of millions of dollars liquidated each month, these improvements will have a meaningful impact on the protocol’s health and user experience.
Aave Labs