APR vs APY in Crypto?
In the minds of every individual subject to capitalism, the terms “gross salary” and “net salary” are etched. The idea of these terms assists in perfectly knowing what you get and what is taken. Although these terms are not in any way similar to the topic of discussion, there is an expectation that they breed; such expectation is in what is to be received.
The concepts of APR vs APY are acronyms that represent the diverse ways of calculating returns on investments or interest rates on loans. Just like the individual subject to capitalism, a investor is assiduously poised on these terms, as they represent his/her interest in business.
APR,APY, What is the difference?
Annual Percentage Yield (APY) and Annual Percentage Rate (APR) are significant terms for investors in the ecosystem; they assist to calculate returns on investment or on loans. These terms are essential for people involved in activities such as crypto staking (which involves locking up your crypto to participate in maintaining and securing a blockchain network).
APR, or Annual Percentage Yield, is the measure of the interest one will earn on an investment or pay on a loan over 12 months, without accounting for the effects of compound interest. Oftentimes, APR is commonly used to explain the returns from lending one’s cryptocurrency or involvement in liquidity pools.
For example, if one stakes 10 tokens with a 0.5% APR, one would expect to earn 0.5 additional tokens later than 12 months.
Annual Percentage Yield, or APY, affords a more holistic view of one’s potential returns by adding the compound interest. Compound interest is the interest garnered not only on the initial investment but also on the accumulated interest over a period of time.
Factoring compound interest means that the APY results in higher returns compared to APR, all things being equal.
To show the difference between APY and APR, let us paint a picture; follow me. Let us say you invest 1000 tokens in a crypto staking platform. With an APR of 10%, you would earn 100 tokens later than 12 months. If the identical investment had a 10% APY with daily compounding, you would earn about 105 tokens. The difference, although small, can be higher with a considerable investment or higher rates.
How To Calculate APR and APY
Since they measure diverse things, each method has a distinct formula. Here’s the formula for APY:
APY = [(1 + r/n)^n] – 1
Here’s the formula for APR:
APR = {[(fees + interest) / P] / n} x 365
You can apply each formula to the data you’re working with to determine APR or APY.
Calculating APY
Where,
“r” = annual interest rate,
“n” = number of times the financial institution compounds your interest in a year.
If you receive interest on the balance of your money or investment each month, your “n” is 12. The symbol “^” represents the number of times you multiply the previous term by itself, so the term “3^5” is the identical as calculating “3 x 3 x 3 x 3 x 3.”
Note: To calculate APY, it’s significant to know the periodic rate, or the annual interest rate, and the number of periods, or times, the interest compounds each year. Consider asking the bank or financial institution what your annual interest rate is.
Calculating APR
It is significant to know significant details about your loan. These include the total interest charge, the length of your loan, the frequency of payments, and the principal, or the amount you borrowed.
Where,
“P” = initial principal balance,
“n” = number of days in a loan term,
“Interest” = total interest you pay over the life of the loan, and “fees” are any costs associated with borrowing money.
Factors that Can Affect APR and APY
Concerning DeFi market conditions, they can result in the fluctuations of APY, unlike traditional finance where APY tends to remain stable
Providing liquidity to decentralized platforms may result in impermanent loss, which affects the actual returns regardless of the stated APY or APR.
This occurs when protocols offer high APYs by minting new tokens; the increased circulation of tokens can lead to inflation, which decreases the value of interests over time
This affects APYs; there is a direct proportionality relationship between the incubation period and APYs. the higher the lock-up period, the higher the APY, and vice versa.
This affects the returns; the higher the frequency of compounding, the higher the yields. For example, daily compounding will result in a higher yield compared to monthly or yahead compounding.
ETH-based platforms incur higher , which can eat into profits and affect one’s APY.
Bottom line
APY and APR are measures that align with an investor’s portfolio performance. An simple way to conduct due diligence on any project could be through crypto staking or yield farming; the point is to capture the largest part of the pie while saving costs. Understanding the distinction between APY vs APR is crucial for making informed decisions while accurately comparing investment opportunities.
