APY vs APR in the Crypto World: Do You Know the Difference Yet?

If you enter the world of digital investing, you will encounter two important terms: APY and APR. Simply put, one is straightforward interest, and the other is interest that “compounds,” making your money grow faster. Confusing these two can lead to poor investment decisions. So, let’s get to know both clearly.

APY: The True Return of Crypto Investment

APY or Annual Percentage Yield is the “annual return percentage” based on compound interest. Its special feature is that it accounts for interest on interest, not just interest on the principal.

In the context of crypto investing, APY reflects your actual return if you let your money work throughout the year. For example, staking or yield farming on DeFi platforms often display APY rates to give investors a clear picture of their potential earnings.

How does compounding increase returns?

Imagine you invest 1 Ethereum at a 6% annual rate. Considering daily compounding, the return will be slightly more than 6% because each day, the interest earned is added back and starts generating additional income.

Comparing different compounding frequencies:

• Semi-annual compounding: APY approximately 6.09%
• Quarterly compounding: APY approximately 6.14%
• Monthly compounding: APY approximately 6.17%
• Daily compounding: APY approximately 6.18%

The more frequently the interest is compounded, the higher the return.

APY in Staking and Yield Farming

When you stake your tokens on a Proof-of-Stake network or provide liquidity in a DeFi platform, the platform displays APY to show how your money will naturally grow over a year.

APR: Basic Interest Rate Without Compounding

APR or Annual Percentage Rate is the “annual interest rate” in a simple form, not considering compounding. It indicates how much interest you will earn or pay over a year, calculated only on the principal.

APR in Lending and Credit Cards

If you borrow 100 units at an APR of 5%, you will pay back 100 units plus 5 units of interest after one year. It’s straightforward, with no complexity from compounding.

For credit cards, APR is the interest charged if you carry a balance. However, note that APR usually does not include additional fees like late payment penalties.

Types of APR: Fixed vs. Variable

Fixed APR: (Fixed): The interest rate remains unchanged throughout the contract period, allowing you to predict your repayment amount accurately.

Variable APR: (Variable): The interest rate can change based on market conditions. Borrowers may pay more if the market moves significantly.

APR in Crypto Lending

On some DeFi platforms, the interest paid to lenders may be shown as APR instead of APY. If you lend 1.0 ETH at an APR of 24%, you will receive 0.24 ETH interest after a year, totaling 1.24 ETH.

APY vs APR: The Essential Difference

How to Calculate APR and APY

APR Calculation Formula

The basic formula for APR is straightforward:

APR = P × T

where P is the periodic interest rate, and T is the investment period.

Example: If you invest 10 Bitcoin at an APR of 6%, you will earn 0.6 BTC per year.

APY Calculation Formula

APY uses a more complex formula because it accounts for compounding:

APY = ((1 + r/n)^n - 1)

where r is the annual interest rate in decimal, and n is the number of compounding periods per year.

Example: If the APR is 6% compounded daily (n=365): APY = ((1 + 0.06/365)^365 - 1) ≈ 6.18%

Applying APY and APR in Crypto Investments

Staking: Let your money work

Staking involves locking your tokens on a Proof-of-Stake network to secure the system and earn rewards. Most platforms display APY so you know how much your investment will grow.

Currently, many DeFi projects even offer daily interest payments for staking, making your money grow in real-time.

Yield Farming: Earning from liquidity

Yield farming involves providing tokens to liquidity pools via dApps. Simply put, you act as a liquidity provider for others and earn rewards. APY rates are often higher than regular staking, but the risks are also increased.

Real Examples Comparing APR and APY

Let’s look at an example with 10,000 baht:

Scenario 1: Only APR considered

• At 5% per year: earns 500 baht/year
• Over three years: earns 1,500 baht, total 11,500 baht

Scenario 2: APY with annual compounding

• 5% APY compounded yearly over 3 years:
  • Year 1: 10,000 + 500 = 10,500 baht
  • Year 2: 10,500 + 525 = 11,025 baht
  • Year 3: 11,025 + 551.25 = 11,576.25 baht
• The total increase is 576.25 baht due to compounding.

Although it seems small, imagine investing millions of baht on a DeFi platform offering 50% per year. The difference becomes enormous.

Is APY Better than APR?

It depends on your position:

If you are an investor: APY is better because it shows the real growth of your money, with interest on interest as a bonus.

If you are a borrower: APR is better because it’s lower, meaning you pay less.

Summary: Choose APY for Crypto Investing

In the digital investment world, beginners often confuse APY and APR. The truth is, both are tools to understand the cost or return of an investment/loan.

For crypto investors who want their money to work, always look at the APY, as it reflects the real return. The more frequent the compounding, the higher the growth. This is the magic of long-term wealth accumulation.

However, remember that higher returns usually come with higher risks. Do thorough research and understand the project or platform before letting your money go in.