# π§Interest Rate Model

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Palmy Finance interest rate strategy is calibrated to manage liquidity risk and optimize utilization. The borrow interest rates come from the Utilization Rate $U$.

$U$ is an indicator of the availability of assets in the pool. The interest rate model is used to manage liquidity risk through user incentives:

When an asset is available: a low-interest rate is applied to encourage borrowers.

When an asset is scarce: a high-interest rate is applied to encourage borrowers to repay and depositors to add more assets.

A liquidity risk becomes apparent when utilization is high. It turns problematic as $U$ gets closer to 100%. To adjust the model to this constraint, the interest rate curve is split into two parts around an optimal utilization rate $U_{optimal}$. Before the point $U_{optimal}$, the slope is gradual. After passing that point, it starts becoming steep.

The interest rate$R_t$is as follows:

$if \hspace{1mm} U < U_{optimal}: \hspace{1cm} R_t = R_0 + \frac{U_t}{U_{optimal}} R_{slope1}$

$if \hspace{1mm} U \geq U_{optimal}: \hspace{1cm} R_t = R_0 + R_{slope1} + \frac{U_t-U_{optimal}}{1-U_{optimal}}R_{slope2}$

In the technical implementation of borrowing rates, the calculation method relies primarily on approximations that affect higher interest rates. The actual borrow rate can be resulted as:

$Actual APY = (1+Theoretical APY/secsperyear)^{secsperyear}-1$

Both variable and stable interest models are derived from the formula above with different parameters for each asset.

When $U < U_{optimal}$ the borrowing interest rates increase slowly for the utilization.

When $U \geq U_{optimal}$ the borrow interest rates increase rapidly for the utilization resulting in over 50% APY if the liquidity is fully utilized.

Borrowing with variable interest constantly fluctuates in its interest rate based on usage. In other words, it is not suitable for financial planning.

Borrowing with stable interest maintains its interest rate at issuance until a specific rebalancing condition is met. To rebalance a stable interest rate lower, the stable interest rate$S$needs to be greater than the current stable rate$S_t$ plus a delta equal to 20%: $S \geq S_t + 20\%$.

To rebalance the stable interest rate higher, below two conditions need to be met:

Utilization Rate: $U_t > 95\%$

Overall Borrowing Rate (the weighted average of all the borrow rates): $R_O < 25\%$

Model Parameters

Interest rate parameters have been calibrated per cluster of assets that share similar risk profiles. First, it's crucial to distinguish assets that are used predominantly as collateral (volatile assets) which need liquidity at all times to enable liquidations. These assets require a low Optimal Utilization rate typically calibrated around 45%. Secondly, liquidity on Palmy Finance is an important factor as the more liquidity, the more stable the utilization becomes: interest rates of assets with lower liquidity should be more conservative. For example, low liquidity stablecoins have a low Optimal Utilization Ratio than those with higher liquidity.

It's also key to consider market conditions: how can the asset be used in the current market? A cost to borrow on Palmy Finance must be aligned with market yield opportunities. Alternatively, there will be a rate arbitrage with incentives for users to borrow all the liquidity on Palmy Finance to obtain higher yield opportunities.

If market conditions change, the parameters of the interest rate can be adapted. These changes would have to adapt not only to Palmy Finance's market availability but also to incentives across DeFi.

Interest Rate Model Parameters

Interest Rates

Utilizations vs Interest Rates for each asset are below:

Deposit APY

You can view Palmy Finance deposit APY on Palmy App for each asset.

The average Deposit APY over a period also includes Flash Loan fees.

βNet APY

For your reference, it is calculated at frontend as follows:

Net APY = sum of PL by Asset in USD / Total Deposited in USD

PL by Asset in USD = Interest PL + Reward

Interest PL = deposited * APY in USD - borrowed * APY in USD

Reward = deposited * depositAPR in USD + borrowed * borrowAPR in USD

Utilizations /Interest Rates | $OAS | $WETH | $WBTC |
---|---|---|---|

The borrowing interest paid is distributed as yield for lToken holders deposited in the protocol, except for the share of yields sent to the ecosystem reserve defined by Reserve Factor. This interest rate is paid on the asset that is borrowed and then shared among all the liquidity providers. The deposit APY, $D_t$, is:

$D_t = U_t V_t(1-R_t)$

$U_t$, Utilization Rate

$V_t$, the variable rate

$R_t$, Reserve Factor