Utilisation and Variable Interest Rates
Understand DeFi lending utilisation, kinked interest-rate curves, supplier and borrower rates, reserve factors and the liquidity signals embedded in rate spikes.
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Utilisation measures how much of a lending pool’s supplied liquidity has been borrowed. Most DeFi lending markets use it as the core input to algorithmic interest rates.
Learning objectives
- Calculate lending-pool utilisation.
- Explain why borrow rates often rise sharply above a target or kink utilisation.
- Estimate a simplified organic supplier rate from borrow rate, utilisation and reserve factor.
What it is
If a pool has 100 units supplied and 80 units borrowed, utilisation is 80%. The unborrowed 20 units provide immediate liquidity for withdrawals and new borrowing, subject to protocol mechanics.
Interest-rate models generally increase the borrow rate as utilisation rises. Many use a moderate slope below a target and a much steeper slope above it to discourage further borrowing and attract new supply when liquidity becomes scarce.
How it works
At low utilisation, borrowers may pay modest rates because plenty of liquidity is idle. As utilisation approaches 100%, the economic value of the remaining liquidity rises and the model often charges much higher rates.
Suppliers do not usually receive the full borrow APR. A simplified relationship is supply rate ≈ borrow rate × utilisation × (1 − reserve factor), before incentives and compounding differences.
The rate is path-dependent. A borrower can open at 4% and later face 30% if utilisation spikes. Conversely, a supplier attracted by a 20% APY may see it collapse after new deposits enter or borrowers repay.
Utilisation also signals withdrawal risk. A pool at 99% utilisation may display high yield while having only a small fraction of supplied assets immediately available for withdrawal.
How to analyse it
Read APY together with the full rate curve and available liquidity. The same number can mean normal demand or severe funding stress depending on where utilisation sits.
| Check | Why it matters | What to verify |
|---|---|---|
| Current utilisation | Shows how much liquidity is already committed. | Compare with the kink and historical range. |
| Rate curve | Determines sensitivity of costs to further borrowing. | Model rates at several utilisation points. |
| Reserve factor | Reduces the interest passed to suppliers. | Verify current protocol parameters. |
| Incentives | Can make displayed rates diverge from organic economics. | Separate emission APR from borrower-funded interest. |
Borrowers should stress rate expense over the intended holding period. A small position can remain solvent while becoming economically unattractive because funding cost explodes.
Suppliers should distinguish high rates caused by healthy borrower demand from high rates caused by a run on available liquidity.
Worked example and thought exercise
A pool has £100m supplied, £80m borrowed, a 10% borrow APR and a 10% reserve factor. Utilisation is 80%; simplified organic supplier APR is about 7.2%.
If borrowing rises to £98m and the model’s steep slope pushes borrow APR to 40%, supplier APR can jump—but only £2m of the original £100m remains unborrowed before repayments and new supply.
Thought exercise: why might a rate spike be simultaneously attractive to new suppliers and dangerous to existing borrowers?
Common mistakes and practical workflow
- Looking at supply APY without checking utilisation.
- Assuming a variable borrow rate will remain near its opening level.
- Ignoring reserve factors and token incentives in rate comparisons.
- Treating high utilisation as yield information but not liquidity information.
Practical workflow
- Calculate current utilisation.
- Locate it relative to the model’s kink.
- Model borrower and supplier rates at stress utilisations.
- Separate organic interest from incentives.
- Check available withdrawal liquidity before sizing a supply position.
✅ Knowledge checkpoint
- How is utilisation calculated?
- Why do many models steepen rates above a kink?
- How can a 40% supply rate coexist with poor withdrawal liquidity?
- What role does the reserve factor play in supplier yield?
FAQs
❓ Why are DeFi rates variable?
They are often algorithmically linked to pool utilisation and can adjust as supply and borrowing change.
❓ What happens near 100% utilisation?
Available liquidity becomes scarce and many models raise borrowing costs sharply.
❓ Does the supplier get the full borrow rate?
Usually not. The rate is adjusted by utilisation, protocol reserves/fees and sometimes other mechanics.
❓ Can APY change quickly?
Yes. Large deposits, repayments, borrows or parameter changes can move utilisation and rates rapidly.
📋 Summary
Utilisation is both a pricing and liquidity variable. Rate models use it to balance borrowers and suppliers, so high APY should be interpreted together with the kink, withdrawal liquidity and the risk of rapid rate changes.
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