> For the complete documentation index, see [llms.txt](https://aqualoan.gitbook.io/aqualoan/llms.txt). Markdown versions of documentation pages are available by appending `.md` to page URLs; this page is available as [Markdown](https://aqualoan.gitbook.io/aqualoan/protocol/borrow/interest-rate-model.md).

# Interest Rate Model

Mitigating liquidity risk through the borrow interest rate model

## Interest Rates (APY) & Utilization <a href="#interest-rates-apy-and-utilization" id="interest-rates-apy-and-utilization"></a>

Aqualoan's interest rate algorithm is calibrated to manage liquidity risk and optimize utilization. The borrow interest rates are derived from the utilization 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 encourage debt repayments and additional supply of capital

### Interest Rate Model <a href="#interest-rate-model" id="interest-rate-model"></a>

Liquidity risk materializes when utilization 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 into two parts around an optimal utilization rate   $$U\_{optimal}$$​. Before $$U\_{optimal}$$ the slope is small, after it begins rising sharply.

<figure><img src="https://docs.radiant.capital/~gitbook/image?url=https%3A%2F%2F4106991690-files.gitbook.io%2F%7E%2Ffiles%2Fv0%2Fb%2Fgitbook-x-prod.appspot.com%2Fo%2Fspaces%252FEf0eFUafasp6VXR9Y2NF%252Fuploads%252Ftop5RrXIvpC7C3PHSUMx%252Fimage.png%3Falt%3Dmedia%26token%3Dfc423e4e-667a-4680-af23-5be451ffd503&#x26;width=768&#x26;dpr=4&#x26;quality=100&#x26;sign=8e0e6721&#x26;sv=1" alt=""><figcaption></figcaption></figure>

Since these aspects of the Aqualoan smart contracts are influenced by Aave, please refer to their documentation for further details of the interest rate model:

{% embed url="<https://docs.aave.com/risk/liquidity-risk/borrow-interest-rate>" %}

## &#x20;<a href="#interest-rate-optimizations" id="interest-rate-optimizations"></a>