# Interest rate model

#The most efficient and safe lending on Aptos

Last updated

#The most efficient and safe lending on Aptos

Last updated

**Meso Finance **implements a robust borrow interest rate model to mitigate liquidity risk within the protocol. This model is finely tuned to ensure optimal capital utilization while managing liquidity fluctuations.

The interest rates for borrowing are dynamically adjusted based on the utilization rate (𝑈), which serves as an indicator of the pool's capital availability.

When capital is plentiful, **Meso Finance **sets lower interest rates to incentivize borrowing, thus promoting liquidity within the protocol.

Conversely, in times of capital scarcity, higher interest rates are implemented to encourage debt repayments and additional asset supplying, thereby enhancing the liquidity position of the protocol. This proactive approach ensures that **Meso Finance **maintains a balanced and resilient liquidity profile, safeguarding the interests of its users.

Interest Rate Model

Liquidity risk becomes more pronounced as the utilization rate (𝑈) approaches 100%, indicating high utilization. To address this challenge, **Meso Finance's **interest rate model is tailored to this constraint by splitting the interest rate curve into two segments around an optimal utilization rate (𝑈𝑜𝑝𝑡𝑖𝑚𝑎𝑙).

Below the optimal utilization rate, the slope of the interest rate curve is relatively small. However, as the utilization rate surpasses the optimal threshold, the slope begins to increase sharply. This adaptive approach ensures that Meso's interest rates respond appropriately to changes in utilization, effectively managing liquidity risk and maintaining stability within the protocol.

The interest rate (𝑅𝑡) in **Meso Finance **follows a model that adapts based on the utilization rate (𝑈𝑡):

**Formula Breakdown**

**Definitions**

𝑅 𝑠 𝑙 𝑜 𝑝 𝑒 2 : Rate of increase in 𝑅 𝑠 when 𝑈 exceeds 𝑈 𝑜 𝑝 𝑡 𝑖 𝑚 𝑎 𝑙 .

**Explanation**

Model Parameters

The parameters of **Meso Finance**'s variable interest rate model are influenced by several factors:

**Asset Type**: Assets predominantly used as collateral, especially volatile ones, require consistent liquidity to facilitate liquidations. The interest rate parameters for these assets should reflect their risk profile and liquidity needs.**Asset Liquidity**: The liquidity of assets on**Meso Finance**is a crucial consideration. Assets with higher liquidity tend to have more stable utilization rates. Therefore, the interest rate parameters should be adjusted based on the liquidity profile of each asset, with lower liquidity assets typically having more conservative interest rates.**Market Conditions**: It's essential to align**Meso Finance**'s borrowing costs with prevailing market yield opportunities. If borrowing rates are significantly lower or higher than market yields, it can lead to rate arbitrage, where users exploit the discrepancy to maximize their returns. Therefore, the interest rate parameters should be adjusted to maintain alignment with market conditions and prevent arbitrage opportunities.**Liquidity Mining**: The emergence of liquidity mining has influenced**Meso Finance**'s interest rate model. Adjustments may be made to borrowing costs by altering the optimal utilization rate (Uoptimal) for assets affected by liquidity mining incentives. This ensures that borrowing costs remain competitive while still accounting for the risks associated with liquidity mining rewards.

By carefully considering these factors, **Meso Finance **can tailor its variable interest rate model parameters to effectively manage liquidity risk, maintain alignment with market conditions, and promote stability within the protocol.

Supply rate

The supply rate, also known as the supply Annual Percentage Yield (APY). This rate is generated from the interest paid by borrowers and is distributed among all liquidity providers, excluding a portion designated for the ecosystem reserve as defined by the reserve factor. The supply APY (𝐷𝑡) is calculated based on the asset that is borrowed out and then shared among all liquidity providers.

The formula for calculating the supply rate (SR) in **Meso Finance **is as follows:

where:

This formula calculates the supply rate based on the utilization ratio, borrows, their respective borrow rate, and the reserve factor.

: The base rate or minimum return rate when utilization is zero.

: Current utilization rate, typically a percentage of total available resources being used.

: Optimal utilization rate, where the system or protocol operates most efficiently.

𝑅 𝑠 𝑙 𝑜 𝑝 𝑒 1 : Rate of increase in 𝑅 𝑠 when 𝑈 is increasing but still below or equal to .

**Case 1: **

When the utilization is less than or equal to the optimal utilization :

starts at .

As increases towards , increases linearly at a rate defined by

**Case 2: **

When the utilization exceeds the optimal utilization :

starts at , which is the rate at .

As increases beyond , increases further at a rate defined by

is the Supply Rate,

is a given utilization ratio,

is the Borrow Rate,

is the Reserve Factor.