APY (Annual Percentage Yield) and APR (Annual Percentage Rate) are metrics used in the crypto industry to describe the interest rates or rewards earned by investors lending their crypto assets to networks and people. APY factors in the effect of compounding interest and is generally a higher figure than APR, which represents the annual rate charged for earning or borrowing money.
If you are familiar with DeFi fianance products, you may have encountered the terms APR and APY. APR (annual percentage rate) and APY (annual percentage yield) calculate interest on various crypto investments or loans, such as providing funds to liquidity pools on exchanges, staking, yield farming, and crypto savings accounts.
Some investments pay simple interest based on the APR rate, while others use the APY method to calculate interest paid. As a crypto investor, it’s essential to understand the difference between APR and APY to choose the most profitable income sources for your funds.
Traditional financial institutions use APR to calculate interest on investment and credit products like mortgages, credit cards, car loans, and other types of credit. In cryptocurrency, the APR determines interest on staking, crypto savings accounts, lending, and borrowing with crypto assets.
When lending or making an investment, the APR represents the percentage of interest that investors can expect to earn. It doesn’t consider other fees that borrowers may need to pay, and it doesn’t compound the interest. However, because this simple interest is most commonly used for loans, DeFi users may mistakenly think they’re paying low-interest rates when they borrow funds from applications that use APR.
In reality, the payments may be higher due to compounding. To calculate APR, your profit depends solely on the original investment because it’s a simple interest rate.
Traditional financial institutions frequently uses the term “annual percentage yield” (APY) to describe how much interest you may earn on your investments. In the world of cryptocurrencies, APY stands for an annualized rate of return on investment, taking into account the compound interest rate.
It is more difficult to calculate APY since it takes into account how often the interest rate is altered. Interest might be compounded continuously, daily, weekly, monthly, or yearly which will significantly affect the end result. The interest gained on the initial principal amount and earned on that interest is called “compound interest.”
Because APY ensures the borrows pays a better-fixed interest rate, entrepreneurs and cryptocurrency analysts frequently choose it in the world of Bitcoin. Their cryptocurrency holdings, however, are frozen for a specific amount of time. Users can use cryptocurrency exchanges, accounts, or blockchain services to earn interest, monthly compounding on their Bitcoin account balances.
They may generate passive income by holding their coins and adopting yield farming to supply cash to liquidity networks. This is why APY interest is more practical and lucrative than APR, at least in the opinion of Bitcoin professionals. Trading locked cryptocurrency assets and tracking price changes might impact your income level.
Calculating the APR is simple. And the steps are highlighted below:
APR uses the general formula – APR = R x N
R – Interest rate in a period
N – Number of periods.
For example, if you invest 500 coins at an annual rate of 5%, you’ll have 525 coins by the end of the first year. If you invest that money in the second year, your take-home coin will be 551.25 coins. That is how the compounding occurs with APR. This number, however, does not include any applicable fees.
Suppose you’re investing in a crypto platform that offers interest-earning products. In that case, they may compound interest on a different annual basis: daily, monthly, quarterly, semi-annually, or annually. Unlike APR, the more frequently a platform compounds the annual interest, the higher the returns for investors. Use the following formula to calculate the annual percentage yield (APY).
APY = ((1 + r/n) ^ n) – 1
r = Annual interest rate
n = Number of compounding periods per year.
Also, check out this chart to see how different compounding frequencies impact the number of compounding periods.
The two common types of APRs are fixed and variable APRs. A fixed APR remains constant during the investment period, while a variable APR can change from the previous interest rate based on market conditions or other factors. Borrowers are likely to pay more interest with a variable APR, particularly during periods of volatility.
The annual percentage yield available to crypto holders is affected by internal and external factors. These factors are similar to those in traditional finance and other institutions, and some of them are beyond the control of the crypto community.
Like any other market, cryptocurrency markets are affected by supply and demand. If a particular coin is in high demand, the interest earned on it is generally higher than ordinary interest, and vice versa. When there is plenty of supply, the annual interest rate charged for borrowing crypto tends to be lower, and when there is a shortage, the rate tends to be higher. Therefore, crypto APY is variable and depends on each coin’s level of demand and liquidity.
Irrespective of the sector you’re analyzing, inflation is an important factor to consider when discussing savings. Money’s value depreciating over time is referred to as “inflation.” In the context of crypto assets, inflation is the addition of tokens to the blockchain network.
Certain cryptocurrencies are made with low inflation rates in mind, which attracts buyers more. The network inflation rate you are dealing with will greatly influence your staking results. In areas with significant inflation, the value lost due to inflation may be greater than your APY. This is why understanding the inflation rate of the cryptocurrency you intend to invest in is important.
Also Read: What is the Bitcoin Halving
The rate at which your investment is compounded can affect the APY calculation. If there are more compounding periods, then the APY will be higher. In simple terms, this means that the more your interest compounds, the more it will grow.
Here are some critical differences between APR and APY:
If what you want is to borrow protocol money, then APR rates are typically more favorable than APY rates. However, if you’re looking to invest in crypto for yield, the effect of compounding can work wonders for your personal finance.
Because APR is determined annually, it is better for lenders to shop around for the lowest rates than to put money into crypto assets and hope for a return. The APY, on the other hand, is based on an annual rate that considers compounded returns, which makes investing in crypto assets more advantageous.
When dealing or lending in the cryptocurrency market, which has great returns and significant dangers, it is essential to understand whether your earnings or payments are based on an APR or an APY.
The majority of DeFi tools and cryptocurrencies now use APR. You must manually compound your gains by reinvesting them daily or weekly to optimize your income if you wish to obtain compound interest.
If you are trying to obtain an annual percentage yield in the crypto world, keeping a few things in mind is important. The risks can vary depending on the platform. Still, there are some general factors to consider:
Also Read: What counteryparty risk in crypto
Investors can earn a monetary value or reward by making their crypto tokens available for loans, known as the annual percentage rate (APR). However, not all cryptocurrency exchanges allow you to lend out your coins, and the interest rates for lending out coins can vary greatly depending on the type of loan or currency you choose.
It’s important to note that any changes in the cryptocurrency price can impact the money earned from lending out coins. For investors participating in fixed loan programs, fluctuations in the value of their portfolio should be expected since they won’t be able to exchange the locked-up coins for a specific period of time.
Also Read: Common Crypto Scams and How to Avoid Them
When considering investing in cryptocurrency, there are a few things to keep in mind beyond just comparing APR and APY rates:
Besides earning interest, some platforms offer extra benefits like liquidity provider (LP) tokens, which can be used to earn even more returns.
It’s important to know whether the advertised rates are fixed or variable. Fixed rates stay the same for the entire investment duration, while variable rates can change based on market conditions.
While some platforms offer high APR and APY rates, they may be based on coins with a highly volatile future outlook and high inflation rates. While your investment may be earning high returns, the coin you’re investing in may be losing value in the market. Keep an eye on the current performance of the coin and its future outlook before investing.
Also Read: What is an IDO?
Earned Annual Percentage Yield (APY) through crypto deposits is much higher than traditional savings accounts. You can expect an APY of over 1% in most cryptocurrency projects.
Some popular coins like Tether can bring in 7% APY due to their high demand. You don’t need to lock up your crypto on certain platforms, as some projects offer APYs of over 100%, usually on DeFi platforms. However, it’s important to note that not all projects are reliable, so you should exercise due diligence, especially with higher-yielding projects.
If you are wondering how to compare the two different interest rates, don’t worry because discuss how you can compare them below.
Using the same rate term when comparing products is crucial. Some may present their rates as either APR or APY. Comparing apples to oranges may lead you to believe that a higher APY will yield more interest than a lower APR, which may not be true. You can easily convert APR and APY using online tools to make accurate comparisons. Remember that the same goes for DeFi and other types of crypto products.
To compare services or goods being promoted using crypto APY and APR, you should make sure you convert them. Ensure the accumulating periods for interest are the same when examining two DeFi products with APY. Even though their APRs are the same, one accumulates monthly and the other daily.
The daily compounding rate can provide you with more Bitcoin interest in such a situation. It’s also crucial to understand what APY implies concerning the service you are analyzing. In the crypto space, certain collateral products use the word “APY” to refer to the rewards one can receive in cryptocurrencies during the chosen duration.
You must understand this because crypto asset prices can be volatile, and the value of your investment, when converted to traditional money, may either increase or decrease.
If you plan to hold onto cryptocurrency for a long period of time, it’s wise to explore opportunities to earn passive income. Here are the top 3 opportunities for you to explore.
Lending platforms connect borrowers with lenders in the world of crypto. When a borrower needs a loan, they request it from a lending platform. After the platform approves the request, the borrower puts up their crypto as collateral. The lender earns interest payments on the principal amount, much like a traditional bank. Once the borrower repays the loan in full, they get their crypto collateral back.
Investing in crypto lending is a straightforward process. There are two types of lending platforms to consider: decentralized and centralized. Decentralized lending platforms use smart contracts to facilitate transactions without intermediaries. On the other hand, centralized platforms involve a third party to manage the process.
If you want to take out a loan using your crypto as collateral, you can do so without selling it. Whether you own Bitcoin or any other cryptocurrency, you can borrow money against it. Some people might believe their coins will appreciate over the long term, so they don’t want to sell them.
In such cases, from the borrower’s perspective, you can visit a crypto lending platform and apply for a loan. However, the lender may require you to deposit more crypto than the loan amount, a process known as “over-collateralization.” This strategy is common among lenders as they aim to mitigate their risk. Once the borrower pays the loan, you can receive your crypto back, which might be worth more than before.
Yield farming can earn more crypto by lending your existing crypto. Yield farmers transfer their assets to various platforms to find better interest rates and approach the whole process as a trading strategy.
However, this strategy requires constant monitoring of the APY to take advantage of the best opportunities. Despite this, farmers who earn a good yield usually earn much higher earned annual interest rates than they would from a regular savings account.
Also Read: How to invest in cryptocurrency
Crypto investment and borrowing in the industry can offer higher returns due to the higher APR and APY rates than traditional finance. Understanding the difference between APR and APY rates is important, where APY is a more complex metric and considers compound interest.
If interest is compounded more frequently than once a year, the APY will always be higher than the APR. To calculate the interest accurately, make sure you know which rate you are looking at. Even though these rates may seem confusing initially, understanding them can help you take advantage of more profitable opportunities in the crypto market.