Utilisation-based lending and borrowing in the crypto space is a system where the interest rates are determined by the ratio of borrowed assets to the total supply of assets available to lend.
Here's a simple breakdown of how it works:
Supply and Demand: Users supply their crypto assets to a lending pool and earn interest, while borrowers take loans from that pool and pay interest.
Utilisation Rate: The utilisation rate is the fraction of the total supplied assets that are currently borrowed. For example, if there is a total of 100 ETH in a lending pool, and borrowers have taken out 50 ETH, the utilisation rate is 50%.
Interest Rates: Interest rates are dynamically adjusted based on the utilisation rate. Typically, when the utilisation rate is low, the interest rates for borrowers are lower, and the returns for lenders are also lower. This is because there’s an abundance of capital to lend, and less demand for borrowing.
Increasing Rates to ensure Liquidity: As the utilization rate increases (meaning more of the supplied assets are borrowed), the system programatically increases the interest rates. This discourages borrowing by making it more expensive and encourages more lending by offering higher returns, aiming to balance out the supply and demand.
By using smart contracts, this mechanism operates automatically on the blockchain, providing a DeFi service that adjusts to market conditions without the need for a traditional financial intermediary.
Curved Interest Rate Model:
The curved interest model is structured to align with the Jumprate model, maintaining a consistent pattern up to the optimal utilisation threshold. Upon reaching this threshold, it adjusts the borrowing rates upward to promote better liquidity management. This adjustment discourages excessive borrowing and encourages supplying liquidity in low liquidity situations.
Events, such as the USDC depeg where the USDT market reached 100% utilization, were quite extreme and highlighted the importance of setting the right incentives for liquidity management. Though such situations may be rare, it is crucial to be prepared and have mechanisms in place that encourage borrowers to act responsibly and help maintain market stability.
Additionally, this model has the added benefit of tempering the fluctuation of interest rates near the optimal utilization mark. This results in a more stable and predictable interest rate trajectory for users, enhancing their financial planning and experience.