Supply-Demand Feedback Loops

Supply-demand feedback loops are the self-regulating mechanisms that keep interest rates in equilibrium within lending protocols. When interest rates rise due to high utilization, they naturally attract more lenders seeking higher yields, which increases the supply of assets and lowers the utilization ratio.

This in turn lowers the interest rate, eventually reaching a new equilibrium. Conversely, when rates are low, borrowing becomes cheaper, increasing demand and utilization, which eventually pushes rates back up.

This constant oscillation ensures that the market for credit is always clearing. It is an elegant example of algorithmic market design that replaces human intervention with code.

These loops are the backbone of the protocol's economic stability, ensuring that it remains attractive to both sides of the market. Understanding these loops is key to predicting how protocols will react to sudden changes in market sentiment or liquidity.