We have recently seen that the interest rate to borrow a loan in BAT in the Aave protocol has increased from 100%.

This data has caught the attention of all of us. How is this interest rate possible? How is someone going to be willing to pay this for this loan? Who is paying for it? In this post we will try to answer these questions.

How interest rates work

In any credit system, in order for someone to request a loan (borrower), another must first lend money for the person who requests it (lender). The interest paid by the person who asks for the loan, goes to whoever left their deposits and others could ask for it, the more people leaving their money, the more offer there will be, and therefore less interest will be charged, on the other hand if the money to lend is reduced, As there is more demand and less supply, interest will increase.

How it is calculated in Aave

In Aave, these interests are calculated according to the utilization rate of deposits, in this excel sheet they have published how it is calculated, and how to estimate these data.

Currently if we select BAT, it shows us the utilization rate and the interest rate.

Below we see the table that shows how interest rates increase, when utilization rises, seeing that from 60% of utilization interest is above 100%

As I mentioned earlier, as the offer is reduced, the interest must rise, making those who had requested loans pay a very high interest in order to encourage them to return it to increase the liquidity of the protocol.

How were these rates reach?

If we look within the protocol data, using the api that I commented in this post, we see that from June 21 is when the interest rate shoots up.

If we compare it with the utilization data we see that there is a direct correlation

Looking at the number of loans we see that there are spikes in applications these days.

And if we group the data on the amount of BAT requested by days we see that the total amounts are much higher than the previous ones.

This indicates that in these days there was a much higher demand than usually in BAT, leaving the protocol with low liquidity in this crypto asset, which caused the interest rate to rise.

Why was there this increase in loans at BAT?

These days due to Compound liquidity mining a very high interest rate was being paid to deposit BAT in the protocol, if we look at BAT deposits in Compound these days, we see that they just increase in a very similar way to requests in Aave.

If we look to the average price paid to borrow in Aave, we see that the average of loans requested between June 21 and 23, when demand skyrocketed, were paid on average:

A much lower interest, than Compound paid for having liquidity , which meant that the interests were more than covered, at least for those requested with a fixed rate.

In this way it was possible to request a loan in Aave at a fixed rate below 6% and deposit it in Compound, which gave returns above 30% these days for depositing liquidity

Those who were requested with variable interest, saw how, their interests skyrocketed, making her loan more unsustainable.

Did these high interests produce higher number of liquidations?

People who had borrowed BAT variable interest before this peak demand saw their beginning to charge a very high interest loans, but looking at the number of liquidations, it not apparent that this growth in interest produced more liquidations

Are they keeping these interests or has it been regularized?

At the time of writing this post, the interest paid is much lower,

which indicates that BAT reserves have returned to higher levels, so the money that was borrowed has returned to protocol.

Has Compound influenced this?

At the time of writing this post, the profitability and therefore the rewards in COMP to the users who leave their liquidity in the protocol are low for BAT

So that the users are not incentivized to leave this asset in Compound, as they receive less interest from which they have to pay for the loan, and receive a small amount of COMP tokens with respect to other assets.

Conclusion

In these markets where there are still inefficiencies due to low liquidity, you can see arbitrage opportunities like these, and as an incentive you can move a lot of market from one protocol to another. Once again we see how DeFI allows us to track all this information transparently and verify with data, without having to believe what is happening. Here the statement “Don’t trust, verify” is made possible, thanks to the ease of access to the data.