Interest Rate Model Flaws

Interest rate model flaws refer to mathematical errors or misalignments in the algorithm that determines the cost of borrowing or the yield provided to lenders. These models are usually based on supply and demand dynamics, where rates increase as utilization increases to encourage repayment and discourage excessive borrowing.

If the model is poorly calibrated, it can lead to stagnant liquidity, where interest rates remain too low to attract lenders, or hyper-inflated rates that drive away borrowers. Furthermore, errors in the implementation of these formulas can lead to incorrect interest accrual, resulting in a loss of funds for users.

Audits check the math behind these models to ensure they align with the intended economic design and are resistant to manipulation. By stress-testing the interest rate curves, auditors ensure the protocol remains attractive and stable across a wide range of market conditions.