Interest Rate Model

Every DeFi lending protocol runs on a pricing engine — a set of on-chain rules that automatically sets the interest rate you earn or pay, every single block. That engine is the interest rate model. No committee, no Fed meeting, no loan officer. Just math responding to supply and demand in real time.

If you're depositing funds to earn yield, the model determines your APY. If you're borrowing against your crypto, it sets your cost. Either way, the rate isn't fixed — it moves with the market. Understanding how it moves is the difference between a predictable strategy and a nasty surprise.

How It Works

The core input is utilization rate — the percentage of deposited funds currently borrowed. If a pool holds $10M in USDC and $6M is borrowed out, utilization is 60%. Low utilization means rates are cheap. High utilization means money is scarce, so the protocol raises rates to attract new deposits and cool borrowing demand.

Most protocols use a kinked model — a two-slope curve with a hard bend at a target utilization, typically around 80-90%. Below the kink, rates climb gradually. Cross it, and rates spike sharply. Aave's USDC market, for example, uses an 80% optimal utilization point; above that, the borrow rate jumps aggressively to push utilization back down.

The kink isn't punitive — it's a circuit breaker. If utilization hits 100%, depositors can't withdraw. The steep rate above the kink is designed to rebalance the pool before it gets there. Borrowers pay more; new lenders rush in for the higher yield; utilization drops. The model self-corrects.

Why It Matters

Your borrow rate on a DeFi protocol is variable by default. That's not fine print — it's the core mechanic. A position that costs you 4% APR today can cost 18% tomorrow if a large borrower enters the same pool and pushes utilization past the kink. You need to know where utilization sits before you open a position, not after.

What to Watch

Lender APY and borrower APR move together — but they're not the same number. The spread between them covers the protocol's reserve factor, a cut taken off the top. At 80% utilization, you might see a 6% borrow rate but only a 4.5% deposit yield. The model publishes both; most dashboards show both. Always check which side of the trade you're on before you anchor to a rate.