Understand utilization-driven interest
By the end, explain the diagram in your own words, solve the case and justify the correction.
Prerequisites : Aave lending pools and aTokens
Level 2 · Intermediate →Reading path · 17 / 35 · 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
- Utilization rises
- Borrow cost responds
- Interest allocation
- Supplier return varies
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.