Interest rates

Introduction

Borrowers pay interest on their outstanding loans when a transaction occurs in a block. Interest is compounded per second. The amount of interest paid at each moment is determined by an Interest Rate Model (IRM) specific to each credit vault from which assets can be borrowed.

Interest rate models

Interest rate models (IRMs) are smart contracts that determine the interest rate based on the vault’s state. Typically, IRMs use a vault's utilisation as an indicator of borrowing demand, ensuring that higher utilisation results in a higher interest rate paid by borrowers.

Linear-kink model

One of the most commonly used IRMs is the "linear-kink" model, where the interest rate increases gradually with utilisation and then sharply rises above a target utilisation threshold. The steep increase discourages over-utilisation, preventing situations where most assets are borrowed and depositors cannot withdraw. While effective, these models often require adjustment by risk curators to align with changing market conditions.

Reactive rate model

A "reactive-rate" IRM adjusts interest rates dynamically based on vault utilisation trends. Instead of setting rates purely based on utilisation at a given moment, reactive models continuously adjust the rate over time. If utilisation exceeds a target threshold, the interest rate keeps rising until borrowers repay or new lenders supply liquidity, reducing utilisation. Conversely, if utilisation drops below the target, interest rates decrease, lowering lender yields and encouraging borrowing.

For a deeper dive into specific IRMs and the theory behind them, see the Advanced Concepts section here.

Fees

By default, 10% of accrued borrowing interest is allocated as a fee, validated by ProtocolConfig. This fee is split equally between the vault governor and Euler DAO. Fees passed to Euler DAO are sent to a fee auction called Fee Flow. Since fees are denominated in vault shares, they compound over time, ensuring that unwithdrawn fees continue to earn interest.