Direct Answer
Borrow APY is the annualized interest rate charged to anyone borrowing an asset from a DeFi lending pool; supply APY is the lower annualized rate paid to anyone who has deposited that same asset into the pool. Supply APY is always less than or equal to borrow APY because only a fraction of supplied liquidity is out earning borrower interest at any moment (the utilization rate), and because most protocols divert a further slice of that interest into protocol reserves (the reserve factor) before the rest reaches suppliers.
Key Takeaways
- Borrow APY and supply APY are two separate rates quoted for the same asset in the same pool - borrowers always pay more than suppliers earn.
- The spread exists because of utilization (not all supplied funds are borrowed) and the reserve factor (a protocol-level cut of borrower interest).
- Approximate relationship: Supply APY ≈ Borrow APY × Utilization × (1 − Reserve Factor).
- Both rates move together and are typically recalculated on every block as pool balances change.
- Interest-rate models are usually piecewise ("kinked") - rates rise gradually below a target utilization and steeply above it.
- The reserve factor funds a protocol's own reserves, used as a buffer against bad debt or liquidation shortfalls.
- Advertised yields above a pool's own supply APY usually come from separate token-incentive rewards layered on top, not from the base interest-rate math.
- Rates are variable and can change quickly - a quoted APY is a point-in-time snapshot, not a fixed return.
The Borrow APY vs Supply APY Formula
Two building blocks determine the spread between borrow APY and supply APY in a typical algorithmic DeFi money market: the utilization rate and the reserve factor.
Utilization = Borrows ÷ (Borrows + Available Liquidity)
Utilization measures the share of a pool's supplied assets that is currently lent out to borrowers. Most protocols feed utilization into a piecewise ("kinked") interest-rate curve: borrow APY rises gradually with utilization up to a target point, then climbs much more steeply beyond it, discouraging utilization from pushing toward 100%.
Supply APY ≈ Borrow APY × Utilization × (1 − Reserve Factor)
The reserve factor is a percentage of borrower interest that the protocol keeps as reserves rather than passing on to suppliers - set per asset by protocol governance, commonly a low single-digit percentage for stablecoins and higher for more volatile assets. This formula is why supply APY sits below borrow APY at every utilization level: at low utilization, only a small share of the pool is generating interest at all, so the average return across all suppliers is diluted; at high utilization, more of the pool is earning interest, so supply APY converges closer to borrow APY, reduced only by the reserve factor.
A Hypothetical Worked Example
The figures below are entirely hypothetical and for illustration only - they do not represent any specific protocol's actual current or historical rates, pool balances, or reserve-factor settings.
Consider a hypothetical stablecoin pool with $100 million supplied and $70 million currently borrowed. Utilization is $70 million ÷ $100 million = 70%. Suppose the pool's rate model produces a borrow APY of 6% at 70% utilization, and the protocol's reserve factor for this asset is set at 10%.
Supply APY ≈ 6% × 0.70 × (1 − 0.10) = 6% × 0.70 × 0.90 ≈ 3.78%.
In this hypothetical scenario, borrowers pay 6% annualized on the $70 million they have drawn, which works out to roughly $4.2 million in annual interest. Suppliers collectively earn roughly 3.78% on the full $100 million supplied, or about $3.78 million annually. The difference - roughly $420,000 in this example - is the reserve factor's cut, retained by the protocol as reserves rather than distributed to suppliers. Now suppose the same pool sees heavy new borrowing that pushes utilization to 90%, past a hypothetical kink point, and borrow APY jumps to 14% on the steeper post-kink slope. Supply APY would then rise to roughly 14% × 0.90 × 0.90 ≈ 11.34% - both rates moved together, and the gap between them widened in absolute terms even as supply APY converged closer to borrow APY in relative terms.
Why the Borrow-Supply Spread Matters
The spread between borrow APY and supply APY is not waste or inefficiency - it is how a pooled lending protocol funds its own risk buffer. Reserves accumulated through the reserve factor are typically the first resource a protocol can draw on to cover bad debt if a borrower's collateral is liquidated for less than the outstanding loan, which can happen during fast price moves or thin on-chain liquidity for the collateral asset. Without a reserve factor, any shortfall from an under-collateralized liquidation would fall directly on suppliers.
The spread also gives a protocol (or its governance) a lever to manage growth and safety at the same time. Raising the reserve factor on a riskier asset widens the spread and builds reserves faster, at the cost of a lower supply APY that may reduce the incentive to deposit. Lowering it does the reverse. Comparing the borrow APY, supply APY, and implied reserve factor across pools and protocols is one way to gauge how conservatively a given market is being run - a wider spread at the same utilization generally signals a higher reserve factor and a larger risk buffer being built for that asset.
Limitations and Common Mistakes
- Rates are variable, not fixed. Borrow APY and supply APY are typically recalculated every block based on live utilization - a quoted rate can change materially within minutes during volatile markets, unlike a fixed-income coupon.
- Advertised "yield" often includes incentives beyond the base rate. Token liquidity-mining rewards layered on top of supply APY are a separate reward stream with their own risk (token price volatility, program discontinuation) - they are not part of the borrow-supply interest-rate formula itself.
- Reserve factors differ by protocol and by asset. The same utilization and borrow APY can produce different supply APYs across pools depending on each asset's governance-set reserve factor.
- Supply APY is a pool-wide average, not a per-depositor guarantee. It reflects the blended return across all supplied funds in that block; it is not a locked-in rate for any individual deposit.
- A high supply APY is not a risk-free return. It still carries smart-contract risk, collateral and liquidation risk on the borrow side of the pool, and - for volatile assets - the underlying asset's own price risk.
- This is not a guarantee of future rates. Past or currently displayed APY figures do not predict what utilization, and therefore what rates, a pool will see going forward.
Frequently Asked Questions
Why is borrow APY always higher than supply APY?
Borrow APY is always higher than supply APY in a pooled DeFi lending market because of two structural factors. First, unless a pool is at 100% utilization, only part of the supplied liquidity is actually earning interest from borrowers at any given moment, so the interest paid by borrowers gets spread across a larger base of supplied funds when converted into a supply rate. Second, most protocols route a reserve factor - a small percentage of the interest borrowers pay - into a protocol-owned reserve rather than passing all of it to suppliers. Both effects reduce supply APY below borrow APY for the same pool.
What is the reserve factor in DeFi lending?
The reserve factor is the percentage of interest paid by borrowers that a lending protocol retains as reserves instead of distributing to suppliers. It is set per asset by protocol governance and typically ranges from a small single-digit percentage for low-risk stablecoins to a larger share for more volatile or riskier assets. Reserves accumulated this way are generally used as a buffer against bad debt from undercollateralized positions or liquidation shortfalls, and in some protocols can also fund insurance modules or treasury operations.
How does utilization affect the borrow-supply APY spread?
Utilization does not change the reserve factor, but it changes how close supply APY tracks borrow APY. Supply APY is roughly borrow APY multiplied by utilization multiplied by (1 minus the reserve factor), so at low utilization only a small fraction of the pool is generating borrower interest and the gap between borrow APY and supply APY is wide in relative terms. As utilization rises toward 100%, a larger share of supplied funds is earning interest from borrowers, and supply APY converges closer to borrow APY, adjusted only by the reserve factor.
Can supply APY ever exceed borrow APY?
Under a standard algorithmic interest-rate model, no - supply APY is mathematically derived from borrow APY multiplied by utilization and the retained-interest share, both of which are fractions no greater than one, so supply APY cannot exceed borrow APY from the same base formula. Advertised yields can appear to exceed a pool's own borrow APY only when a protocol layers additional incentives on top, such as token liquidity-mining rewards paid separately from the base interest-rate model - that additional yield is a separate reward stream, not a change to the underlying borrow-versus-supply math.
What is a kink in an interest rate model?
It is the utilization level at which the rate curve changes slope, rising gently below and steeply above. Protocols place one there to keep utilization near a target: below the kink, borrowing is cheap enough to encourage use, and above it the rate climbs sharply to attract new supply and discourage further borrowing before the pool runs out of withdrawable liquidity. Where the kink sits and how steep the upper segment is are governance parameters, so the same utilization produces different rates in different markets.
Are DeFi lending rates fixed or continuously variable?
Continuously variable in the pooled designs these metrics describe. The rate is a function of current utilization, recalculated as balances change, so it moves whenever anyone deposits, borrows or repays. A borrower does not lock a rate at origination; they pay whatever the model produces at each accrual. This is why a quoted borrow APY is a snapshot rather than a term, and why a borrower's realised cost over a period can differ substantially from the figure shown when they opened the position.
Does a quoted lending APY include incentive token rewards?
Sometimes, and dashboards differ on it. The interest component comes from borrowers and is paid in the asset supplied. An incentive component is paid in a separate token funded by emissions, and its value depends on that token's price and on the program continuing. Combining the two into one headline figure mixes a contractual rate with a variable subsidy. Reading them separately shows how much of an advertised return would survive if the incentive program ended.
How does APY differ from APR in a lending pool?
APR is the simple annualised rate with no compounding assumed. APY assumes the interest earned is itself earning, compounded at whatever frequency the protocol accrues, which for on-chain lending is effectively every block. The gap between the two widens as the rate rises, so at low rates they are close and at high rates the difference is material. Comparing a protocol quoting APY against one quoting APR without converting overstates the first.
Why can a supplier's realised return fall short of the advertised supply APY?
Because the advertised figure is an instantaneous rate annualised, and the actual rate changes constantly with utilization. A supplier earns the time-weighted average of whatever the rate was while they were in the pool, and depositing at a moment of peak utilization means capturing the high rate only until borrowers repay or new supply arrives. Incentive rewards, if any, also accrue at whatever the reward token was worth when claimed rather than when earned.
Related Reading
References
Borrow APY, supply APY, and reserve-factor mechanics are defined by each DeFi protocol's own smart-contract code and published documentation, which vary by protocol and change over time as governance adjusts interest-rate-model and reserve-factor parameters. Readers researching a specific pool's live borrow APY, supply APY, or reserve factor should consult that protocol's own documentation and on-chain contract state directly rather than relying on general educational summaries like this one.
Disclaimer
This content is for educational purposes only and does not constitute investment, financial, tax, or legal advice. Swoopr Investment does not recommend any specific DeFi protocol, lending pool, or on-chain strategy. DeFi lending involves smart-contract risk, liquidity risk, and collateral-liquidation risk, and borrow APY and supply APY are variable rates that can change quickly and should not be treated as a fixed-income guarantee. See our Financial Disclaimer for more information.