Interest Rate Model
Mitigating liquidity risk through the borrow interest rate model
Last updated
Mitigating liquidity risk through the borrow interest rate model
Last updated
Blend’s interest rate algorithm is calibrated to manage liquidity risk and optimise utilisation. The borrow interest rates are derived from the Utilisation Rate U.
U is an indicator of the availability of capital within the pool. The interest rate model manages liquidity risk in the protocol through user incentives to support liquidity:
When capital is available: low interest rates to encourage borrowing.
When capital is scarce: high interest rates to encourage repayments of debt and additional supplying.
Liquidity risk materialises when utilisation is high, and this becomes more problematic as U gets closer to 100%. To tailor the model to this constraint, the interest rate curve is split in two parts around an optimal utilisation rate Uoptimal. Before Uoptimal the slope is small, after it begins rising sharply.
The interest rate Rt follows the model:
The resulting actual borrow rate is as follows:
When U≤Uoptimal the borrow interest rates increase slowly with utilisation
When U>Uoptimal the borrow interest rates increase sharply with utilisation to above 50% APY if the liquidity is fully utilised.
Variable debt see their rate constantly evolving with utilisation.
Alternatively, stable debts maintain their interest rate at issuance until the specific rebalancing conditions are met. In interest models are optimised by new rate strategy parameter Optimal Stable/Total Debt Ratio to algorithmically manage stable rate.
First, it’s crucial to distinguish assets that are used predominantly as collateral (i.e., volatile assets), which need liquidity at all times to enable liquidations. Second, the asset’s liquidity on Blend is an important factor as the more liquidity, the more stable the utilisation. The interest rates of assets with lower liquidity levels should be more conservative.
It is also key to consider market conditions (i.e., how can the asset be used in the current market?). Blend’s borrowing costs must be aligned with market yield opportunities, or there would be a rate arbitrage with users incentivized to borrow all the liquidity on Blend to take advantage of higher yield opportunities.
With the rise of liquidity mining, Blend adapted its cost of borrowing by lowering the Uoptimal of the assets affected. This increased the borrow costs that are now partially offset by the liquidity reward.
Variable rate parameters:
Uoptimal
Base Variable Borrow Rate
Variable Rate Slope 1
Variable Rate Slope 2
Stable rate parameters:
Uoptimal
Base Variable Borrow Rate
Variable Rate Slope 1
Variable Rate Slope 2
Stable to Total Debt Ratio
The stable rate provides predictability for the borrower; however, it comes at a cost, as the interest rates are higher than the variable rate.
The assets that are most exposed to liquidity risk do not offer stable rate borrowing.
The base rate of the stable rate model corresponds to the average market rate of the asset.
Stable Interest Rate Rebalance
In certain conditions, the protocol enables stable rates to be rebalanced to avoid a large percentage of liquidity being borrowed at a stable rate below market variable rate.
The borrow interest rates paid are distributed as yield for aToken holders who have supplied to the protocol, excluding a share of yields sent to the ecosystem reserve defined by the reserve factor. This interest rate is generated on the asset that is borrowed out then shared among all the liquidity providers. The supply APY, Dt, is:
St=Ut(SBtSt+VBtVt)(1−Rt)
Ut, the utilisation ratio
SBt, the share of stable borrows
St, the average stable rate
VBt, the share of variable borrows
Vt, the variable rate
Rt, the reserve factor
The average Supply APY over a period also includes Flash Loan fees.
