Interest Rate Model
The formula a DeFi lending protocol uses to set borrowing and lending rates based on a pool's current utilization rate.
An interest rate model is the specific mathematical formula a DeFi lending protocol uses to determine borrowing and lending interest rates for a given asset pool, based primarily on that pool's current utilization rate (see Kaavon's "Utilization Rate" glossary definition). Most models are piecewise, with interest rates rising gradually as utilization increases up to a target level, then rising much more steeply beyond that level to strongly discourage pushing utilization toward 100%, where depositor liquidity would become severely constrained.
Different protocols and even different asset pools within the same protocol can use different interest rate model parameters — such as the target utilization threshold, the base rate, and the steepness of the rate curve above and below that threshold — reflecting different judgments about the right tradeoff between capital efficiency and liquidity safety for that specific asset. Because the interest rate model directly determines what borrowers pay and what lenders earn, understanding a specific pool's model and its current position on that curve is central to evaluating a DeFi lending position's expected return and risk.
Examples
- A typical interest rate model keeps rates low and gradually rising below 80% utilization, then rises very steeply above that threshold to strongly discourage pushing utilization any higher.
- Two lending pools for the same asset on different protocols can have meaningfully different borrowing costs at the same utilization rate, simply because they use different interest rate model parameters.