Stable Borrow Rate

The core feature is a predictable cost of capital. Unlike variable-rate loans where interest can spike during market stress, a stable rate is set at inception and remains constant, allowing for precise financial planning and budgeting. This is typically achieved through mechanisms like rate stabilization reserves or fixed-rate lending pools.

Protocols implement stable rates through various models:

• Isolated Fixed-Rate Pools: Lenders deposit into dedicated pools offering a fixed yield, which funds corresponding fixed-rate loans.
• Interest Rate Swaps: Protocols may use derivatives to hedge variable yield from underlying assets, converting it to a stable payout for lenders and borrowers.
• Algorithmic Stabilization: Some models use supply/demand algorithms with smoothing functions or time-averaged rates to minimize short-term volatility.

Borrowers benefit from predictable repayment schedules, which is critical for structured financial activities like:

• Leveraged Yield Farming: Calculating precise profitability.
• Working Capital Loans: Managing business cash flow.
• Long-term Financing: Undertaking multi-year projects without interest rate risk. It eliminates the danger of a liquidation spiral triggered by sudden rate increases.

Stability often comes at a cost. Borrowers typically pay a premium over the current variable rate for the certainty. This premium compensates lenders for forgoing potential higher yields during volatile periods. Additionally, stable-rate loans may have less liquidity or early exit penalties to protect the pool's economic model.

Key differences:

• Risk Profile: Stable rates transfer interest rate risk from borrower to lender/protocol; variable rates leave it with the borrower.
• Cost: Stable rates are often higher initially but predictable; variable rates are cheaper in calm markets but uncertain.
• Use Case: Stable for planning; variable for short-term, opportunistic borrowing.

Several DeFi protocols specialize in or offer stable-rate products:

• Notional Finance: Uses fCash tokens to represent fixed-rate positions.
• Yield Protocol: Implements fixed-rate lending and borrowing via fyTokens.
• Aave (V2/V3): Historically offered a 'stable rate' mode, though it could rebalance under extreme conditions. These protocols create markets for future cash flows, decoupling rate from immediate spot price.

The primary alternative to a stable rate, where the interest on a loan fluctuates based on real-time supply and demand in the liquidity pool. Key characteristics include:

• Dynamic Pricing: The rate adjusts algorithmically as the pool's utilization ratio changes.
• Market Reflection: Directly signals the cost of capital at any given moment.
• Common Use: Often preferred for short-term borrowing or when users anticipate stablecoin demand to decrease.

A core risk metric in lending protocols calculated as Total Borrows / Total Liquidity. It critically influences interest rate models:

• Rate Driver: High utilization pushes variable rates up to incentivize repayments or more deposits.
• Protocol Health: Acts as a gauge for liquidity risk; extremely high ratios can trigger protocol safeguards.
• Stable Rate Impact: The availability and pricing of stable rates are often gated by the pool's overall utilization.

A derivative agreement where two parties exchange cash flows of different interest rate types. In DeFi, this concept is mirrored when users switch between stable and variable borrow rates.

• Hedging Function: Allows a borrower to lock in a stable rate to hedge against future variable rate increases.
• Protocol Mechanism: Switching typically involves repaying one loan type and instantly reopening another, often with a small fee.

The foundational smart contract that holds deposited assets and facilitates borrowing. It is the source of funds for both rate types.

• Capital Source: All borrowed funds, whether at stable or variable rates, are drawn from the shared pool of supplied assets.
• Rate Calculation: The pool's aggregated supply, borrows, and utilization are inputs for the interest rate model that determines both variable and stable rates.
• Risk Isolation: Pools are typically asset-specific, meaning the stable rate for DAI is independent of the rate for USDC.

ERC-20 tokens that represent a user's debt position. The type of token dictates the interest rate model applied.

• StableDebtToken: Minted upon taking a stable rate loan. Its balance represents the principal, and interest accrues at a fixed rate, added to the principal upon any operation.
• VariableDebtToken: Minted for a variable rate loan. The balance increases continuously as accrued variable interest is compounded.
• Accounting Mechanism: These tokens are burned upon full repayment, and their type determines the applicable interest calculations.