What Is Annual Percentage Yield (APY)?

Annual Percentage Yield (APY) of a cryptocurrency is the effective one-year rate of return on investment in a cryptocurrency with compounded interest. It differs from simple interest because APY reflects how often gainbtcs are compounded or reinvested during the time period.

In real life, APY is applied to indicate how much your crypto assets will grow in a year if you continue to reinvest the reward or interest you earn. It's applied heavily in yield farming, staking, crypto lending, and savings websites to determine your assets' true growth.

For instance, if a DeFi protocol is providing 10% APY on stablecoin deposits and compounding daily or weekly, your return at the end of one year will be slightly greater than 10% because of compounding.

So, then what is apy and apr in crypto?

It is a large number that allows you to compare various investment options and see the total earning potential of your crypto assets, especially in those systems that automatically re-invest rewards.

Annual Percentage Yield (APY) vs. Annual Percentage Rate (APR)

The fundamental difference between APY and APR in cryptocurrency is how they treat compounding. While both are annualized, they calculate returns in really a different way.

APR stands for Annual Percentage Rate and is a simple percentage rate of interest without regard to any investment that you are making out of your earnings. It is computed on the simple method of interest. For instance, you invested a sum of $1,000 in a platform that lends with 10% APR. You will be getting exactly $100 in a year - if there is no compounding.

APY, or Annual Percentage Yield, is the impact of compound interest. It's the amount that you actually see when your reward is being reinvested all the time on a regular time interval. What that does is cause your returns to rack up faster, especially if rewards are being compounded weekly or daily. The same example: an investment of $1,000 generating a 10% APY compounded monthly would be more than $100 in the first year.

So in terms of returns, the question is what is the difference between APR and APY in crypto. APR is what you'd have if you don't do anything with your rewards. APY is what you'd have if your rewards get re-invested automatically. On most staking and DeFi platforms, APY will provide a better impression of what you'll be having remaining - especially if you're not redeeming rewards frequently.

What Is APR (Annual Percentage Rate)?

Cryptocurrency Annual Percentage Rate or APR is just the straight interest rate you pay or get back on a loan or investment over a year without compounding. It's a very nice metric to use to describe fixed lending charges or fixed returns on most CeFi and DeFi protocols.

For instance, if you borrow a USDT loan on a centralized exchange with an interest rate of 8% APR, you will receive 8% of the initial amount after 12 months - without the compounding interest. For a crypto loan of 12% APR, that's the annual fixed fee of the loan, without compounding interest added as well.

APR is predominantly used in:

• Crypto lending sites (e.g., Nexo, BlockFi)

• Borrow/lend protocols like Aave or Compound

• Liquidity pools with delayed returns

• Credit line products on crypto-fintech products

When farming or staking, platforms will report APR in scenarios where rewards are disbursed but not automatically compounded. Investors, in such scenarios, need to reinvest manually to earn payouts almost as large as APY-level.

So when comparing yield-bearing products, it's important to know what is APR and APY in crypto, and what one is being marketed - because the distinction can have a dramatic impact on your actual earnings.

How to Calculate APY in Crypto

To realize your actual return on crypto investments, it's useful to know how APY is calculated. As opposed to APR, which is linear and straightforward, APY takes into account compound interest, and thus, your rewards earn more rewards over time.

Here is the easy formula for APY:

APY = (1 + r/n)ⁿ - 1

Where:

• r is the yearly interest rate (as a decimal)

• n = number of compounding periods per year

Let's try it with a crypto example:

You deposit a stablecoin at 10% APY per year and the protocol compounds rewards 12 times per year. Using the formula:

• APY = (1 + 0.10 / 12)¹² - 1

• APY ≈ 10.47%

So, while the rate is quoted at 10%, your effective return - with month-to-month compounding - will be closer to 10.47% at the end of the year.

Some crypto platforms compound daily or even per block, which can make the APY slightly higher. That's why you'll often see APY values that look a bit inflated compared to APR - they reflect the power of compounding over time.

Also watch out for "7-day APY" in crypto, which is a projected one-year yield according to recent performance over the last 7 days. It's commonly displayed in DeFi dashboards to indicate short-term returns to be expected for a whole year. They can be extremely different and are not to be interpreted as guaranteed rates.

Crypto Investments That Earn APY

There are several various types of crypto products and protocols rewarding back in the form of APY. Most of them reward at a fixed interval and re-invest them automatically or offer an option for users to re-invest them on their own - compounding the growth over time.

The following are the most trending crypto investments rewarding APY:

1. Staking

The most frequent method of gaining APY in crypto is by staking, in which the users bond their tokens to validate on the behalf of a blockchain network (i.e., Ethereum, Solana, or Cosmos) and receive rewards every now and then like 4% APY or even more based on the token as well as validator performance.

In platforms like Rocket Pool or Lido, the APY is compounded into token derivatives like stETH, so your balance grows daily automatically without any human intervention.

2. DeFi Yield Farming

Yield farming involves providing liquidity to decentralized exchanges like Uniswap, PancakeSwap, or Curve. Traders receive APY in the form of trading and token charges, which are paid in native tokens or governance tokens.

DeFi protocols typically display what is APY in staking crypto on their homepages - and well over 50% or more. There is volatility and risk of impermanent loss with high APY if costs-free.

3. Savings Accounts

Centralized services like Nexo, YouHodler, and the recently canceled BlockFi have offered crypto interest accounts with reputed APYs. They borrow your crypto against institutions or margin traders and return a percentage of the yield to you.

They are neither DeFi nor custodial services with money not yours. Counterparty risk must be factored in when depositing.

4. Stablecoin Pools

Stablecoin farming or lending - USDC, USDT, or DAI tokens - will yield lower but stable APYs. They are extremely attractive to risk-averse investors, especially with compounding automatization.

5. Liquid Staking Derivatives:  

Lido (stETH), Frax (sfrxETH), and Coinbase's cbETH are just some of the protocols providing liquid staked ETH that accrue staking rewards. They can be routed elsewhere in DeFi while continuing to earn staking APY in the background.

APY Significance

Everyone who is interested in growing their crypto wealth by staking, yield farming, or interest accounts should be aware of what is APY in crypto refers to. APY provides the actual rate of return after compounding, and more often than not, it makes it a more accurate estimate of potential returns than APR. Whether you stake your ETH, farm stablecoins, or utilize DeFi protocols, APY allows you to compare between platforms' yield opportunities with ease.

Even if APY figures look appealing, especially for high-yield DeFi pools, remember that more yield means more risk - for example, impermanent loss, smart contract exposure, or platform insolvency. Make sure to learn the formula used to calculate rewards, the compounding frequency, and if APY is variable, fixed, or derived with short-term measures like 7-day APY rates. Lastly, the choice between APR and APY is all about knowing how your rewards build up over time - and which sites are best suited for your risk appetite and financial aspirations.