How Do Lenders Use LTV Ratios to Determine Interest Rates in Traditional and Decentralized Finance?

In traditional finance, a lower LTV ratio is seen as less risky for the lender, and this often results in a lower interest rate for the borrower. A higher LTV implies more risk, so lenders charge a higher interest rate to compensate.

In decentralized finance, the interest rate is typically determined algorithmically based on the supply and demand for borrowing in a specific lending pool, rather than being tied directly to an individual's LTV. However, the protocol's overall risk parameters, which are influenced by LTV, can indirectly affect the cost of borrowing for everyone.