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APY vs. APR

APR vs. APY in Crypto: The Difference Between Them

Published On: October 31, 2022
Both APY and APR are very commonly used terms in DeFi (Decentralized Finance) applications. For those who are not familiar with DeFi, you might have asked yourself “what is the difference between APR vs. APY in crypto?”

While the two are similar, they are not the same. APY stands for Annual Percentage Yield which includes compound interest. On the other hand, APR stands for Annual Percentage Rate, and it does not comprise the compound interest. Both of them are important metrics for crypto investors to decide where they should put their funds next.

APY vs. APR - How to Calculate

Between the two, APR (Annual Percentage Rate) is easier to calculate. APR is how much interest rate a lender can earn annually or interest rate a borrower needs to pay annually.

Think of it like in traditional finance where a lender gets money plus interest rate after one year. For example, you lend $100,000 to a lending platform app and you charge 12% APR. In this case, you will get $112,000 back after one year.

How about APY? Well, the math to calculate APY is not as simple as APR because it needs to include compound interest.

Compound interest is the compounded amount of interest a lender can earn over a certain period of time. Using the above example, let’s say the borrowers inside the lending app have to pay $1,000 interest rate every month (instead of $12,000 all at once annually), that means you can just put back the $1,000 to the same platform as soon as you get them, and also get more money the following month. 

Why? Because in the second month your total capital wouldn’t be $100,000 anymore, but instead, you would have $101,000, and thus you would get $1,010 from the interest. And after you receive this $1,010, once again you would put it back to the same lending app, and the cycle continues.  This is what compound interest is all about.

Thanks to compound interest, you can make more money at the end of the 12th month, as compared to the simple APR calculation above. This is how you calculate APY. APY is the annual return on the lender’s investment that includes the calculation of compound interest.

Keep in mind that the above example with compound interest differs from one DeFi application to another. Different DeFi applications have different compounding frequencies. Some DeFi applications might allow you to claim the interest rewards every few minutes while others only allow you to claim every 24 hours, etc. And due to all these differences, the APY calculations are also different.

How to Find Attractive APR or APY

This is actually the more complicated topic to talk about. The easiest way to find a DeFi application’s APR and APY is to visit the DeFi application frontend and check the numbers that they list. 

For example, if you are interested in putting your stablecoins to one specific DeFi application, most likely they would show you the APY number from the moment you connect your web3 wallet to their frontend.

Compare the DeFi application’s APY to other existing DeFi applications, and you will find out which one has the more attractive APY.

One crucial thing to remember is that not all APY numbers listed on DeFi application websites are accurate. As we have mentioned above, the real APY calculation will differ depending on the compounding frequency.

A DeFi app that allows you to claim reward every one hour will provide higher APY compared to another DeFi app that only allows you to claim reward every one month, considering everything else is equal.

The thing is, occasionally, some DeFi apps might not be transparent about the reward claim frequencies (how often you can claim every day, how often you can re-stake the reward etc.). Make sure you always test everything with a smaller amount of funds before you commit serious money.

Another important point to consider. Many DeFi apps calculate the APY in their own native crypto token’s valuation instead of the predicted yield in stablecoin or fiat currency value. Just like the previous advice, you should “test the water” by using smaller amounts of funds, to avoid miscalculation. Only commit a larger amount of funds after you figure everything out.

Conclusion

APR vs. APY are often used interchangeably by casual DeFi investors despite the fact that the two are different. Always remember that APR does not include compound interest while APY does. And every time you find a new DeFi app that can offer attractive APY for your crypto funds, always test it out with a smaller amount of funds.
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