What is APY in crypto? Annual percentage yield explained

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

In this article, we’ll 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 as it is not only important but also gives information that helps you to invest more effectively.

APY vs compound interest

First, you must 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 compounding is the process of adding interest earned every period on both the original investment and the reinvested earnings (herein the interest earned from the previous period).

To better illustrate these concepts, we’ll provide an example:

You have $100 and you lend it to someone at an interest rate of 10% annually in Jan. 2020. In Jan. 2021, you hope to get your money back and receive an interest amount of $10.

The sum of money you would receive after a year equals:

100 * (1+10%) = $110

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

In the first 6 months, you would have:

100*(1+5%) = $105

The sum of money you would receive after a year equals:

105*(1+5%) = $110.25

So at the end of Jan. 2021 when you get your money back you get $110.25. This 25 cent is the magic of compound interest.

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

What is APY in crypto: APY explained

What is APY in crypto? APY (annual percentage yield) 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 immediately added to the balance. With each subsequent period, the account balance gets slightly larger, so the interest paid on the balance is also larger.

APY is a way of measuring how much money a money market account earns over the course of a year. To put it another way, this is a method for measuring the accumulation of interest over time.

How does APY work in crypto? If you are a crypto investor looking to get a return on your investment while holding it, cryptocurrency savings accounts with APY may be precisely what you need. There are a variety of cryptocurrency yield schemes to select from. As a result, before joining up for one, do your research. Fees, entry restrictions, interest-earning procedures, and the types of crypto assets accessible may differ from platform to platform.

There are also promotional APYs offered by crypto exchanges, but you should be cautious before investing in them. Some of these programs employ the tactic of first giving higher APYs to attract clients and then lowering the rates after a large pool of customers has been captured. If you come across a yield farming platform or program that offers high APYs, make sure to examine its community trustworthiness.

APY examples:

Staking rewards

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

Yield farming

Example: On a DeFi platform like Uniswap or SushiSwap, you provide liquidity to a trading pair like ETH/USDT. The APY for providing liquidity might 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. The APY could be around 8-12%, so if you deposit $1000 USDC, you might earn $80 to $120 in interest over a year.

Crypto lending

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

Crypto savings plans

An example is Binance’s fixed-term savings options, like Flexible Savings or Fixed Savings. Depending on the term and the cryptocurrency you choose, you might see APYs ranging from 5% to 15%.

How is APY calculated in crypto

Here’s a detailed explanation of how APY is calculated.

APY calculation formula

APY = (1 + r/n)^n – 1

In which:

• r is the periodic rate of return (referred to as 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 affecting APY in crypto

What you end up earning with APY in crypto depends on the platform’s interest rate and the type of crypto you’re using. Supply and demand on DeFi platforms also play a big part. Don’t forget that platform fees and costs can impact your overall earnings. Lock-up periods and staking or yield farming strategies may influence yields as well. Finally, broader market conditions and risk factors associated with the crypto asset can affect the APY.

APY vs APR in crypto: what’s the difference

Annual percentage yield vs 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 with an APR of 10% and that interest is calculated once a year, you will receive $100 interest after 1 year.

And APY will be based on the effect of compound interest. If you still use 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 6 months of the year, you will add 50 USD in the money received in the first 6 months. At this point, the amount you receive will be 52 USD (1050 * 10% / 2).

APR is usually charged on credit card loans, this is the interest rate charged on the outstanding balance of the credit card that the person has not paid. Meanwhile, APY will apply to the case of businesses coming to deposit money at banks. Banks often use APY to attract customers to deposit money.

Usually banks will keep secret the difference between annual percentage yield vs annual percentage rate. However, if you take a look at the above example, you can see that the higher the annual interest rate, the bigger 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. While you are applying for a credit card or loan, they will insist on the APR to show you the actual cost to be paid.

Benefits and risks of APY in crypto

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

Benefits

APY in the crypto world can be really attractive, often offering much higher returns than traditional savings accounts. For instance, some platforms might give you yields between 5-15% or even more. It’s a great way to enhance your earnings, especially since traditional banks often offer such low interest rates. 

Engaging in crypto staking, yield farming, or lending means you can earn money passively from your crypto holdings without being tied down to constant trading. You can also spread your investments across different assets and strategies to manage risk better. Many crypto savings options offer flexible terms, so you can get to your funds or reinvest them 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 traditional finance.

Risks

Cryptocurrencies can be very volatile, so the value of your investments might swing up and down a lot, even if the APY looks great. There’s also the risk of platform issues — DeFi platforms and exchanges can sometimes face security problems, hacks, or other failures that could result in losing your funds. 

Since the regulatory landscape for crypto is still changing, new laws might affect how APY-earning platforms function or your ability to access your funds.

Also, some crypto savings plans might require you to keep your money locked up for a while, which could limit your access to your funds when you need them.

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