FOLLOW THE MECHANISM
- 1Borrowed share
Pool accounting measures demand against supply.
- 2Rate curve
Configured parameters map utilization to a borrow rate.
- 3Allocation
Interest is split between supplier claims and retained amounts.
- 4Feedback
Repayments and new supply change the next state.
A conceptual sequence. Real implementations can add steps, intermediaries, and conditions.
A price for access to liquidity
Borrow interest pays for using someone else’s assets over time. In many DeFi pools, a formula links the rate to utilization: the share of supplied liquidity currently borrowed, under the protocol’s accounting definition. As more funds are borrowed, fewer remain available for withdrawal or additional loans. A higher rate can discourage borrowing and attract supply, but it cannot force either response. A high displayed rate is therefore also information about market conditions, not simply an attractive payout.
Why a kink appears
Aave V3 documents a two-slope rate strategy with an optimal usage point. Below that point, borrowing rates rise on one slope; above it they rise on another. The parameters are configured per reserve and can change through authorized processes. The steeper region is intended to make scarce liquidity more expensive. It is an incentive mechanism rather than an automatic restoration of cash. If borrowers cannot or will not repay, high rates can increase recorded debt while the liquidity shortage persists.
The supplier rate is a different number
In a simplified pool with 1,000 supplied units and 800 borrowed, utilization is 80%. At a 10% borrower APR, borrowers generate about 80 units of annual simple interest if balances and the rate stay fixed. If the protocol retains 10% of that interest, suppliers share 72 units, equivalent to 7.2% of the supplied balance. The model omits changing indices and other adjustments, but shows why borrower and supplier rates are not generally equal.
Annualized does not mean locked for a year
A variable annualized rate is a snapshot convention. A loan can accrue interest over a much shorter interval, and its rate can change before the interval ends. Some products instead specify fixed terms, matching or auctions. A rate comparison must include which asset is owed, whether interest compounds, reserve or service fees, and incentive payouts. The interest-rate mechanism also interacts with liquidation: a rising debt balance can reduce health even when all market prices are unchanged.
MAKE IT CONCRETE
Zero utilization boundary
In the simple model, no borrowing means no borrower-funded supplier interest, even if the quoted base borrowing rate is positive. Any supplier reward at that point needs another identified funding source.
FAILURE PATHS & COMMON MISREADINGS
Where the model can break
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