The learning path
You can deposit crypto to earn interest, or borrow against crypto without selling it. Both are governed by four numbers, and the one that matters is the price at which the protocol takes your collateral automatically. Here it is worked through with real figures.
The idea in one paragraph
You deposit crypto into a shared pool and earn interest from people borrowing from it. Or you borrow from that pool, leaving more crypto than you take out as collateral. There is no credit check and no repayment schedule, because the loan is secured by assets the protocol can seize automatically the moment your position gets too thin. That automatic seizure is the entire subject.
The four numbers that decide everything
| Term | What it means | A real example |
|---|---|---|
| Loan to value (LTV) | The most you are allowed to borrow against a deposit, at the moment you borrow. | Around 80% against ETH on the largest lending protocol, as of August 2026. |
| Liquidation threshold | The higher level at which the protocol takes your collateral. The gap between this and LTV is your entire safety margin. | Around 83% against ETH. So the margin between the maximum borrow and forced sale is about three points. |
| Health factor | Collateral value times the threshold, divided by what you owe. Below 1.0 you are liquidated. | Deposit $10,000 of ETH at an 83% threshold, borrow $6,000, and your health factor is 1.38. |
| Liquidation penalty | The discount a liquidator gets on your collateral for repaying your debt. You pay it. | Around 5% on ETH. On a $15,000 partial liquidation that is $750, gone. |
What liquidation actually looks like
Numbers, because this is the part people do not feel until it happens. Assume ETH at $4,000, an 83% liquidation threshold and a 5% penalty.
You deposit 10 ETH and borrow $30,000 of stablecoin
That is $40,000 of collateral against $30,000 of debt, a 75% ratio. Under the limit, and aggressive. Your health factor is 1.107.
Work out the price that liquidates you, before you borrow
0.83 times 10 ETH times the price has to stay above $30,000, so the price has to stay above $3,614. That is a fall of 9.6%. Ether has moved more than that in an afternoon many times.
ETH falls 10% to $3,600
Your collateral is $36,000. Health factor 0.996. You are now liquidatable, and the seizure happens in one block, with no warning, no phone call and no grace period.
A liquidator repays half your debt and takes collateral plus the penalty
They pay $15,000 and take $15,750 of your ETH, which is 4.375 ETH. You are left holding 5.625 ETH and still owing $15,000. The penalty cost you $750.
And you owe tax on it
The seized ETH is a disposal at $3,600, whether you wanted to sell or not. You get the tax bill for a sale you did not choose, at a price you did not like.
Now the same deposit with $16,000 borrowed instead of $30,000. Health factor 2.075, and the liquidation price is $1,928, a fall of 52%. Same asset, same protocol, same market. The only thing that changed is how much was borrowed.
Why a comfortable rate can become an uncomfortable one
Borrow rates are not fixed and nobody votes on them. They are set by a formula tied to how much of the pool is currently lent out. Below a target level the rate rises gently. Above it, the formula turns punitive on purpose, to force borrowers to repay so that depositors can withdraw.
In April 2026 an exploit elsewhere in the ecosystem drained available liquidity from the largest lending pool in about two hours. Ether borrow rates went from roughly 2.3% to about 8.7%. Stablecoin deposit rates hit 13%, and one stablecoin borrow rate sat pinned at its ceiling near 14% for four days while utilization stayed above 99.8%.
Risks a beginner will not think of
| Risk | What it is | When it actually happened |
|---|---|---|
| Smart contract bug | A flaw in the lending contract drains the pool. Your deposit is not insured by anyone. | Euler Finance, March 2023, $197m. Unusually, the attacker returned the funds. |
| Dependency failure | The lending protocol is fine and something it relies on is not. | April 2026: a forged cross chain message minted about $292m of unbacked collateral, which was then borrowed against. The bad debt ran into the hundreds of millions. |
| Oracle error | Your position is priced by a data feed. If the feed is wrong you are liquidated at a price that never existed. | March 2026: a pricing cap misvalued a staked ETH token by 2.85%, liquidating about $27m across 34 users. The protocol compensated them. |
| Bad debt socialized onto depositors | Collateral seized too slowly, or worth less than the debt. The shortfall lands on the protocol and ultimately on lenders. | Aave and CRV, November 2022, $1.6m. Modern backstops work by burning staked deposits, which is not insurance. |
| Governance risk | Whoever controls the votes can change the rules while your position is open, including the thresholds you sized against. | Compound, July 2024: a proposal moved $24m of treasury to a whale led wrapper before being rescinded. |
| Curator risk | On newer platforms an individual or firm, not a DAO, picks which markets your deposit funds. | This is the dominant model on the second largest lending protocol as of 2026. |
| Collateral depeg | A "stable" asset stops being stable and every position built on it breaks at once. | USDC fell to 86 cents in March 2023. In November 2025 a yield bearing token fell from $1.00 to $0.26 in a day, with $285m of exposure across lending vaults. |
This is not what Celsius was
The lenders that failed in 2022 were a different product wearing similar words. With Celsius, BlockFi, Voyager and Genesis you transferred ownership to a company, which lent your coins onward, frequently without collateral, to borrowers you could not see. When they failed you were an unsecured creditor in a bankruptcy, not the owner of anything.
The onchain lending protocols kept operating and liquidating normally throughout the same period, because their losses were bounded by collateral rules that anyone could inspect. That is a real distinction and it is worth understanding rather than flattening into "crypto lending is dangerous".
Where the bankruptcies got to, as of the most recent filings we could confirm: Celsius creditors had recovered about 60% of their July 2022 claim value as of November 2024, with further distributions since; BlockFi's administrator secured 100% of allowed claim values; Genesis returned 51% of bitcoin and 66% of ether coin for coin, which was over 150% of the dollar value at filing. Voyager's recoveries are less clearly documented in public sources.
The tax position, including what is unsettled
Settled: liquidation is a taxable disposal, measured by your basis against the value when the collateral was seized. Interest you pay is not deductible for personal spending, though it may be if the borrowing funded investment or business activity. Crypto is property, so the wash sale rule does not currently apply, although bills to change that are pending.
Not settled, and you should know this: whether a crypto loan is a loan at all for tax purposes has no clear answer. The IRS has explicitly deferred, suspending reporting on lending of digital assets pending "further study". The professional consensus is that borrowing is not a taxable disposal, reasoning by analogy to securities lending rules that do not by their terms cover digital assets. Treat the tax deferral argument as probable rather than certain, and talk to somebody who does this for a living before relying on it.
Common questions
Why would anyone borrow instead of just selling?
What is a health factor?
Will I be warned before liquidation?
Can I lose more than I put in?
Is depositing safer than borrowing?
Is this the same thing as Celsius?
Do I owe tax when I borrow?
Where to go next
Stuck on this one?
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