# Interest Rate Model

Novel interest rate model on the Algofi Lending V2.

The Algofi protocol uses a non-linear interest rate model to ensure smooth market dynamics and sufficient liquidity at all times.

As the Borrow Utilization increases within a given market, the borrow rate increases in response to this demand.

After the Borrow Utilization surpasses a certain level called Optimal Utilization, the borrow rate begins to increase more quickly to encourage a return to the equilibrium level. As a result, markets tend to borrow less than or equal to their Optimal Utilization.

The Optimal Utilization discourages borrowing above a certain fraction of the market which keeps the protocol safe and liquid and ensures lenders have sufficient assets to redeem.

The interest rate borrowers pay also depends on a parameter called Optimal Utilization. The utilization of a market, Borrow Utilization, is the ratio of borrowed capital over supplied capital. For example, if a market has $100 USDC in supply and $50 is borrowed, then the Borrow Utilization = 50%.

If Borrow Utilization is less than Optimal Utilization, then the borrow interest increases as a function of Borrow Utilization like so:

`Borrow Interest Rate = Base Interest Rate + (Borrow Utilization / Optimal Utilization) * Slope Under Utilized`

The term Slope Under Utilized

*measures how much the Borrow Interest Rate increases as the Borrow Utilization increases. If Optimal Utilization is 80% and Slope Under Utilized is 4%, then a 10% increase in Borrow Utilization would result in 0.50% increase in the Borrow Interest Rate.*If Borrow Utilization is greater than Optimal Utilization the protocol adds an additional term that carries a higher penalty (Slope Over Utilized) to disincentivize Borrow Utilization over Optimal Utilization. In sum, the borrow interest rate sums the Base Interest Rate and

`Borrow Interest Rate = Base Interest Rate + Borrow Utilization * Base Interest Slop + (Borrow Utilization - Optimal Utilization)**2 * Quadratic Amplification Factor`

With the following parameters:

Parameter | Value |
---|---|

Base Interest Rate | 0 |

Optimal Utilization | 50% |

Base Interest Slope | 10% |

Quadratic Amplification Factor | 200% |

The borrow interest rate curve as a function of Borrow Utilization is:

The non-linear borrow rate "turns on" when the borrow utilization exceeds 50%. With the specified model parameters a maximum borrow interest rate of 60% can be achieved.

Suppliers earn their share of interest paid by borrowers. This is calculated mathematically as

`Supply Interest Rate = Borrow Utilization * Borrow Interest Rate * (1 - Reserve Factor)`

Last modified 10mo ago