How does AAVEs interest rate model adapt to market changes?

Question

I’m curious about how AAVEs interest rates adjust in response to supply and demand fluctuations. Can someone explain the mechanism behind the interest rate model and how it ensures liquidity on the platform? Specifically, how does AAVE determine variable versus stable interest rates, and what factors can lead to shifts between the two? Insights into any recent changes in rates and the reasons behind them would also be helpful!

Black Crypto Wolf · Answer

AAVEs interest rate model adjusts based on the supply and demand dynamics within its lending pools. The platform uses two types of rates: variable and stable. Variable Interest Rates: These are determined by the current market demand and supply for assets in the pool. When demand for borrowing increases, rates rise to incentivize more supply; conversely, if demand decreases, rates drop. Stable Interest Rates: These are fixed over time and designed to protect borrowers from sudden interest rate fluctuations. Stable rates are typically set a bit higher than variable rates but offer more predictability. The transition between these two rates occurs based on factors like market volatility, liquidity, and the overall health of the lending pool. For example, if the variable rate becomes too volatile, more users may choose stable rates, prompting AAVE to adjust the mechanism to keep liquidity balanced.

How does AAVE's interest rate model adapt to market changes?

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