What does APY mean in crypto? If you participate in yield farming, you may have heard of APY or APR. They are used in many yield farming programs in DeFi protocols.
In this article, we make the explanation of APY in crypto simple and show you how to calculate it in your yield farming. Be patient and read the article to the end because it is not only important but also provides information that will help you invest more effectively.
APY vs Compound Interest
First, you need to learn the difference between simple interest and compound interest to understand APY in crypto.
Simple interest is the interest earned only on the original deposit, while compound interest is the process of adding the interest earned each period on both the original investment and the reinvested income (herein the interest earned from the previous period) .
To better illustrate these concepts, let’s give an example:
You have €100 and you lend it to someone in January 2020 at an interest of 10% per year. In January 2021 you hope to get your money back and receive an interest amount of € 10.
The amount of money you receive after one year is equal to:
100 * (1+10%) = €110
Now let’s look at another scenario. In this case, you also have $100, and you lend it to your friends at an interest rate of 10% per year. The loan is compounded semi-annually.
In the first 6 months you will:
100*(1+5%) = $105
The amount of money you receive after one year is equal to:
105*(1+5%) = $110.25
So if you get your money back by the end of January 2021, you’ll get $110.25. This 25 cents is the magic of compound interest.
Compounding allows you to generate money over time, which is why it is such a powerful investment tool. This is not the same as simple interest. The term “simple interest” refers to interest earned only on the principal amount.
What is APY in crypto: APY explained
What is APY in crypto? APY (Annual Percentage Yield) is the effective annual rate of return, taking into account the effect of compound interest. Unlike simple interest, compound interest is calculated periodically and the amount is added to the balance immediately. With each subsequent period, the account balance increases slightly, so the interest paid on the balance also increases.
APY is a way to measure how much money a money market account makes over the course of a year. Put another way, this is a method of measuring the accumulation of interest over time.
How does APY work in crypto? If you are a crypto investor looking to earn a return on your investment while holding it, cryptocurrency savings accounts with APY may be just what you need. There are several cryptocurrency return schemes to choose from. Therefore, do your research before signing up for this. Fees, access restrictions, interest earning procedures, and the types of crypto assets accessible may vary from platform to platform.
There are also promotional APYs offered by crypto exchanges, but you should be careful before investing in them. Some of these programs use the tactic of first offering higher APYs to attract customers and then lowering rates after a large group of customers have been acquired. If you come across a yield farming platform or program that offers high APYs, be sure to research the trustworthiness of the community.
APY examples:
Set up rewards
Example: You stake Ethereum (ETH) on a platform such as Coinbase or Binance. The APY can be around 4-6%, which means if you stake 10 ETH, you can earn 0.4 to 0.6 ETH over a year.
Agriculture yield
Example: On a DeFi platform like Uniswap or SushiSwap, you provide liquidity to a trading pair like ETH/USDT. The APY for providing liquidity can be 10-20% depending on trading volume and fees.
Savings accounts
Example: You deposit USDC into a crypto savings account on platforms such as Celsius or BlockFi. The APY can be around 8-12%, so if you deposit $1000 USDC you could potentially earn $80 to $120 in interest over a year.
Crypto loans
Example: You lend Bitcoin (BTC) on a platform such as Aave or Compound. The APY for lending BTC can be 3-7%, so if you borrow 1 BTC you can earn 0.03 to 0.07 BTC in interest annually.
Crypto Savings Plans
An example is Binance’s fixed-term savings options, such as Flexible Savings or Fixed Savings. Depending on the term and cryptocurrency you choose, you may see APYs ranging from 5% to 15%.
How is APY calculated in crypto
Here you will find a detailed explanation of how APY is calculated.
APY calculation formula
APY = (1 + r/n)^n – 1
In which:
- r is the periodic return (also called the annual APR)
- n is the number of years of compounding
For example:
r rate = 55.44%
APY = (1+ 55.44%/365)^365 – 1= 74.02%.
Factors that influence APY in crypto
What you ultimately earn with APY in crypto depends on the interest rate of the platform and the type of crypto you use. Supply and demand on DeFi platforms also play a major role. Remember that platform fees and charges can impact your overall earnings. Lock-up periods and staking or yield farming strategies can also affect yields. Finally, broader market conditions and risk factors associated with the crypto asset can impact the APY.
APY vs. APR in crypto: what’s the difference
Annual Return vs. Annual Percentage Rate: Is There a Difference Between the Two?
When it comes to APR in the context of savings, it means a recurring rate. For example, if you save €1,000 in your account with an APR of 10% and that interest is calculated once a year, you will receive €100 in interest after 1 year.
And APY will be based on the effect of compound interest. Still using the example above, you have $1,000 with an APY of 10% and that interest is paid twice a year. For the first 6 months you get 50 USD (1000 * 10% / 2).
However, in the last six months of the year, you will add USD 50 to the money you received in the first six months. Currently, the amount you receive is 52 USD (1050 * 10% / 2).
APR is usually charged on credit card loans, which is the interest charged on the outstanding balance of the credit card that the person has not paid. Meanwhile, APY will apply to companies that come to deposit money in banks. Banks often use APY to attract customers to deposit money.
Normally banks will keep the difference between the annual yield and the annual interest rate secret. However, if you look at the example above, you will see that the higher the annual interest rate, the greater the difference between APR and APY.
The difference between APR and APY can have a significant impact on the financial decisions of borrowers and investors. In summary, banks often emphasize APY to attract savings account investors and show how high interest rates are. While you are applying for a credit card or loan, they will insist that the APR shows you the actual charges to be paid.
Benefits and risks of APY in cryptocurrency
What are the main benefits and risks of APY in crypto?
Advantages
APY can be very attractive in the crypto world and often offers much higher returns than traditional savings accounts. For example, some platforms can give you returns of 5-15% or even more. It’s a great way to increase your income, especially since traditional banks often offer such low interest rates.
By participating in crypto staking, yield farming, or lending, you can passively monetize your crypto holdings without being tied to constant trading. You can also diversify your investments across different assets and strategies to better manage risks. Many crypto savings options offer flexible terms, allowing you to access your money or reinvest it as you see fit.
And with all the innovative financial products in the crypto space, you get access to unique earning opportunities that you won’t find in the traditional financial world.
Risks
Cryptocurrencies can be very volatile, so the value of your investments can fluctuate up and down a lot, even if the APY looks great. There is also the risk of platform issues: DeFi platforms and exchanges can sometimes experience security issues, hacks, or other glitches that could cause you to lose your funds.
Because the regulatory landscape for crypto is still changing, new laws could impact how APY-earning platforms function or your ability to access your funds.
Additionally, some crypto savings plans may require you to keep your money locked up for a while, which can limit your access to your money when you need it.
Frequently asked questions
How often is APY paid?
APY uses compound interest, which means your interest is added to your balance at certain times. This way you earn interest on your initial deposit and the interest added over time. How often this happens can vary: some platforms may increase interest rates daily, while others may do so monthly or annually.
Is a higher or lower APY better?
A higher APY often means you can get more out of your investment. Don’t forget to review other details, such as costs and potential risks, before jumping in.
What does 5 percent APY mean?
A 5 percent APY means that if you leave your money invested for a year, you’ll end up with 5 percent more than you started with.
