What is APY in crypto? Annual percentage yield explained

What does APY mean in crypto? If you are into yield farming you may have already heard of APY or APR. They are used in many yield farming programs in DeFi protocols.

In this article, we will simplify the explanation of APY in crypto 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 and compound interest

To understand APY in crypto, you must first learn the difference between simple interest and compound interest.

Simple interest is interest earned only on the original deposit; Compound interest, on the other hand, is the process of adding interest earned each period to both the original investment and reinvested earnings (here, interest earned from the previous period).

We will give an example to better explain these concepts:

You have $100 and you lend it to someone in January 2020 at a 10% annual interest rate. You hope to get your money back in January 2021 and receive $10 in interest.

The total money you will receive after one year is equal to:

100 * (1+10%) = $110

Now let’s look at another scenario. In this case, you have $100 and you lend it to your friends at a 10% annual interest rate. The loan is compounded semi-annually.

In the first 6 months you will have:

100*(1%+5) = $105

The total money you will receive after one year is equal to:

105*(1%+5) = $110.25

So when you get your money back at the end of January 2021, you will receive $110.25. This is the magic of 25 cents compound interest.

Compounding allows you to generate money over time, which is why it’s such a powerful investment tool. This is not the same as simple interest. The term ‘simple interest’ refers only to the interest earned on the principal deposit.

What is APY in crypto: APY explained

What is APY in crypto? APY (annual percentage return) is the effective annual return, taking into account the effect of compound interest. Unlike simple interest, compound interest is calculated periodically and the amount is instantly added to the balance. In 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. In other words, this is a method for measuring the accumulation of interest over time.

How does APY work in crypto? If you’re a crypto investor looking to earn returns while holding your investment, cryptocurrency savings accounts at APY may be exactly what you need. There are various cryptocurrency return plans to choose from. Bottom line, do your research before joining one. Fees, entry restrictions, interest earning procedures, and 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 the rates once a large pool of customers has been captured. If you come across a yield farming platform or program that offers high APYs, be sure to check out the credibility of the community.

APY examples:

Staking rewards

Example: You stake Ethereum (ETH) on a platform like Coinbase or Binance. APY can be around 4-6%, meaning if you stake 10 ETH, you can earn 0.4 to 0.6 ETH in a year.

yield farming

Example: On a DeFi platform like Uniswap or SushiSwap, you provide liquidity to a trading pair like ETH/USDT. 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 like Celsius or BlockFi. APY can be around 8-12%, meaning if you deposit $1000 USDC, you can earn $80 to $120 in interest within a year.

crypto loan

Example: You lend Bitcoin (BTC) on a platform like Aave or Compound. The APY for BTC lending can be 3-7%, meaning if you lend 1 BTC you can earn 0.03 to 0.07 BTC in annual interest.

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 find APYs range from 5% to 15%.

How is APY calculated in crypto?

You can find a detailed explanation of how APY is calculated here.

APY calculation formula

APY = (1 + r/n)^n – 1

In which:

r is the periodic rate of return (referred to as annual APR) n is the number of compounding years

For example:

r rate = 55.44%

APY = (1+ 55.44%/365)^365 – 1= 74.02%.

Factors affecting APY in crypto

What you earn in crypto with APY depends on the platform’s interest rate and the type of crypto you use. Supply and demand on DeFi platforms also play a big role. Keep in mind that platform fees and costs may affect your overall earnings. Lock-in periods and staking or yield farming strategies can also affect returns. Finally, broader market conditions and risk factors associated with the cryptoasset can affect APY.

APY and APR in crypto: what is the difference

Annual percentage return and annual percentage rate: is there a difference between them?

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 at 10% APR and that interest is calculated annually, you will receive $100 in interest after 1 year.

APY, on the other hand, will be based on the effect of compound interest. If you continue using the example above, you have $1,000 with an APY of 10%, and that interest is paid twice a year. You will receive 50 USD (1000 * 10% / 2) for the first 6 months.

However, in the last 6 months of the year, you will add 50 USD to the money you received in the first 6 months. At this point, the amount you will receive will be 52 USD (1050*10%/2).

APR is usually charged on credit card loans; This is the interest rate applied to a person’s unpaid credit card balance. Meanwhile, APY will also apply to businesses that come to banks to deposit money. Banks often use APY to attract customers to deposit money.

Usually banks keep the difference between annual percentage return and annual percentage rate secret. But if you look at the example above, you can 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 investors in savings accounts and show how high interest rates are. When applying for a credit card or loan, they will insist that the APR show you the actual cost you will be charged.

Benefits and risks of APY in crypto

What are the key benefits and risks of APY in crypto?

Benefits

In the crypto world, APY can be really attractive and often offer much higher returns than traditional savings accounts. For example, some platforms can give you returns of 5-15% or more. It’s a great way to increase your earnings, especially since traditional banks often offer such low interest rates.

Participating in crypto staking, yield farming or lending means you can passively earn money from your crypto assets without having to rely on constant trading. You can also spread your investments across different assets and strategies to better manage risk. Many crypto savings options offer flexible terms so you can access your funds or reinvest them as you see fit.

With all the innovative financial products in the crypto space, you can access unique earning opportunities that you cannot find in traditional finance.

Risks

Cryptocurrencies can be very volatile, so even if the APY looks great, the value of your investments can rise and fall a lot. There is also the risk of platform issues; DeFi platforms and exchanges can sometimes encounter security issues, hacks, or other malfunctions that could cause you to lose your money.

As the regulatory environment for cryptocurrency is still changing, new laws may impact the operation of APY-earning platforms or your ability to access your funds.

Additionally, some crypto savings plans may require you to keep your money locked up for a period of time, which may limit your access to your funds when you need them.

FAQ How often is APY paid?

Since compound interest is used in APY, your interest is added to your balance at regular intervals. This way, you earn interest on your initial deposit and interest added over time. How often this happens may vary; Some platforms may increase engagement on a daily basis, while others may do so on a monthly or annual basis.

Is a higher or lower APY better?

A higher APY generally means you can earn more on your investment. Be sure to check out other details like fees and potential risks before you get started.

What does 5 percent APY mean?

An APY of 5 percent means that if you leave your money invested for a year, you’ll get 5 percent more than the amount you started with.