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Understand utilization-driven interest
Useful first : Aave lending pools and aTokens
Reading path · 17 / 41 · Intermediate
Borrower interest funds supplier returns, after protocol allocations.
The essentials
Borrower interest funds supplier returns, after protocol allocations. Reserve utilisation is one factor in the rate model: as available liquidity becomes scarce, borrowing can become more expensive, encouraging repayments and additional supply.
How it works
A displayed variable rate is a snapshot rather than a commitment for the coming year. APR states an annual rate without assuming compounding; APY includes a compounding convention. Token incentives should be separated from interest earned in the supplied asset, especially when the incentive token’s price is volatile.
What to watch
High utilisation may coincide with attractive rates and limited immediate withdrawal liquidity. Yield and availability are different properties. A useful scenario specifies the rate, compounding frequency, fees, time horizon and denomination, while acknowledging that a constant-rate calculation cannot predict an actual DeFi return.
Understand the details
Utilization relates borrowed funds to the reserve’s supplied liquidity under the market’s accounting. Rate curves commonly increase borrowing cost as liquidity becomes scarce, sometimes more steeply beyond a target point. This provides an incentive for repayment and new supply, but an incentive is not a guarantee that users react immediately.
Boundaries and common mistakes
Supplier and borrower rates are not normally identical. Utilization and protocol allocations influence how borrower interest reaches suppliers. APR and APY also differ because APY includes an assumed compounding convention. A displayed current rate is not a fixed promise for the whole holding period.
The mechanism at a glance
- 01Utilization rises
- 02Borrow cost responds
- 03Interest allocation
- 04Supplier return varies
Read these as connected concepts, not necessarily consecutive steps.
Read the explanation
Utilization relates borrowed funds to the reserve’s supplied liquidity under the market’s accounting. Rate curves commonly increase borrowing cost as liquidity becomes scarce, sometimes more steeply beyond a target point. This provides an incentive for repayment and new supply, but an incentive is not a guarantee that users react immediately.
Put the mechanism into context
Assume a simplified pool has 1,000 supplied units and 800 borrowed. Borrowers pay 10% annually and 10% of their interest is retained by the protocol. Calculate annual interest paid and the amount available to suppliers, holding all values constant.
Apply it in the workshop →What this mechanism does not guarantee
Supplier and borrower rates are not normally identical. Utilization and protocol allocations influence how borrower interest reaches suppliers. APR and APY also differ because APY includes an assumed compounding convention. A displayed current rate is not a fixed promise for the whole holding period.
The distinction that changes the analysis
If a variable rate changes midway through a period, applying the final displayed rate to the whole period gives the wrong interpretation. Break the period into intervals and use each interval’s assumptions. An advertised current APY is not a history of earned interest.
Explain it yourself
Revisit the case above. Name what is established, what remains to be checked and the evidence needed to conclude. A strong answer addresses both sides of the diagram.
Apply the lesson to a case
Assume a simplified pool has 1,000 supplied units and 800 borrowed. Borrowers pay 10% annually and 10% of their interest is retained by the protocol. Calculate annual interest paid and the amount available to suppliers, holding all values constant.
Borrowers pay 80 units; 8 are retained and 72 reach suppliers. Across 1,000 supplied units, that is 7.2% before other effects. This is an accounting illustration, not an Aave rate quote. Changing utilization during the year changes the result.
Prepare a correction note
Describe the passage and the proposed correction. This creates a local note for you to share; it sends nothing. Do not include personal or confidential information.