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Overview

Interest Rate Models (IRMs) determine the borrowing and supply rates for each vault based on utilization. Each vault can have its own custom IRM, allowing for flexible rate structures.

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Utilization

Utilization is the percentage of deposited assets that are currently borrowed: 
Utilization = Total Borrowed / Total Deposited
  • Low Utilization (e.g., 20%): More assets available, lower borrowing rates
  • High Utilization (e.g., 90%): Fewer assets available, higher borrowing rates

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Rate Calculation

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Supply Rate

The supply rate is the interest earned by lenders. It’s calculated as: 
Supply Rate = Borrow Rate × Utilization × (1 - Reserve Factor)
The reserve factor is a percentage of interest that goes to the protocol (typically 0-20%).

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Borrow Rate

The borrow rate is determined by the vault’s IRM based on current utilization. Different IRMs use different formulas.

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IRM Types

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Linear IRM

A simple linear model where rates increase proportionally with utilization: 
Borrow Rate = Base Rate + (Utilization × Slope)
Characteristics:
  • Simple and predictable
  • No kink points
  • Rates increase steadily with utilization

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Kinked IRM

A model with a “kink” point (optimal utilization): 
If Utilization < Optimal Utilization:
    Borrow Rate = Base Rate + (Utilization × Slope1)
Else:
    Borrow Rate = Base Rate + (Optimal × Slope1) + ((Utilization - Optimal) × Slope2)
Characteristics:
  • Two different slopes
  • Optimal utilization point (typically 80-90%)
  • Steeper slope after optimal to discourage over-utilization

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Adaptive IRM

Rates adjust over time based on utilization history:
  • If utilization is consistently above target: rates increase gradually
  • If utilization is consistently below target: rates decrease gradually
  • Provides smoother rate transitions

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Custom IRMs

Vaults can implement custom IRMs via hook targets, allowing for:
  • Time-based rate adjustments
  • Governance-controlled rates
  • Market-specific logic

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Example: Kinked IRM

Consider a vault with:
  • Base Rate: 2% APY
  • Optimal Utilization: 80%
  • Slope 1: 10% APY (before optimal)
  • Slope 2: 50% APY (after optimal)
At 50% utilization: 
Borrow Rate = 2% + (50% × 10%) = 7% APY
At 90% utilization: 
Borrow Rate = 2% + (80% × 10%) + ((90% - 80%) × 50%)
            = 2% + 8% + 5%
            = 15% APY

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Dynamic Rate Updates

Interest rates update continuously as:
  • Users borrow more (increases utilization → higher rates)
  • Users repay debt (decreases utilization → lower rates)
  • New deposits arrive (decreases utilization → lower rates)
  • Withdrawals occur (increases utilization → higher rates)

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Rate Impact on Positions

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For Lenders

  • Higher utilization → Higher supply rates → More interest earned
  • Lower utilization → Lower supply rates → Less interest earned

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For Borrowers

  • Higher utilization → Higher borrow rates → More interest to pay
  • Lower utilization → Lower borrow rates → Less interest to pay

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Choosing an IRM

When creating a vault, consider:
  1. Asset Type: Stablecoins might use different curves than volatile assets
  2. Target Utilization: What utilization level do you want to encourage?
  3. Rate Volatility: How quickly should rates respond to changes?
  4. Market Conditions: Different IRMs work better in different market conditions

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References

For more details on IRM implementation: