Interest Rate Spreads

Interest rate spreads in decentralized finance represent the difference between the interest paid to depositors and the interest charged to borrowers. This spread is the primary profit margin for lending protocols, covering operational costs and risk premiums.

By maintaining a healthy spread, the protocol ensures that it can attract enough liquidity to facilitate borrowing while keeping the cost of capital sustainable for users. These rates are often determined algorithmically based on the utilization ratio of the pool, where higher demand leads to increased interest rates to incentivize supply.

The spread effectively manages the supply and demand equilibrium within the protocol. It is a key metric for assessing the efficiency of capital allocation and the overall health of the lending market.