Have you ever wondered what APY and APR mean in crypto investments and what is the difference between the two?
Entering the crypto world basically means that you will be bombarded by various new terminologies related to blockchain. Some of them are also related to banking industries and investments, which may not be familiar to many people. Therefore, it's easy to understand why many investors, especially beginners, might get confused with all these new terms and jargon.
When you invest, take a loan, or lend digital assets, you might come across two important terms: Annual Percentage Yield (APY) and Annual Percentage Rate (APR). While the two terms may sound similar, they are actually quite different. As an investor, it's highly necessary to understand them in order to maximize the interest on investments and minimize the interest paid when taking a loan.
In this article, we will explain everything you need to know about APR and APY and understand the difference between the two.
What is APY?
Annual Percentage Yield or APY is the actual rate of return on an investment that takes the effect of compounding interest into account. It is essentially a metric used to calculate an investor's annual nominal income. In other words, APY is a technique used to measure how interest accumulates over time.
Put simply, the interest that you earn on your funds is called compound interest. It refers to the amount received on both the principal (the money you deposit into your account) and the interest you earn from the investment. Compounding makes it possible to earn money in the long term, so it is certainly a great strategy for investors.
This is also part of the reason why many investments and loans use a compound interest rate to calculate the annual interest earned by the investors. However, it is worth noting that this is not the same as "simple interest", which refers to the interest gained on the main deposit only.
In the crypto space, compound interest is used in crypto savings where investors deposit their assets and receive a rate of return over a certain period of time. This allows investors to get a higher fixed rate of interest. Moreover, there are loads of crypto yield programs to choose from out there. Just make sure to do proper research before signing up for one. Factors like fees, types of crypto, and interest-earning procedures might vary from one service to another.
Apart from that, there are also APY programs that are offered by crypto exchanges. You should be careful before registering because some of these programs offer high APYs to attract new clients only to drastically drop the rates after gaining enough clients. So, if you come across a program that offers unbelievable APYs, make sure to check the credibility of the exchange first.
How to Calculate APY
Here's how you calculate APY in crypto investments:
r = interest rate
n = compound interest period (on APY, usually n = 12 months)
What is APR?
On the other hand, the Annual Percentage Rate or APR is essentially the annual rate of return that you will get within a year or the amount of interest that the borrower needs to pay to investors, expressed in percentage. APR calculates additional costs related to the transaction, and unlike APY, it does not take into account the compounding interest of the investment within the year. APR is often known as a simple interest rate as the profit depends solely on the original investment.
In the crypto space, APR is often used in crypto lending programs. You can either lend your crypto to earn APR or borrow some crypto assets and pay some fees to the lender. Since different platforms offer different rates, it is highly encouraged to stake your assets in multiple platforms to get a high APR.
Generally speaking, there are two types of loans offered by crypto exchanges:
- Fixed lending that requires investors to secure their money for a specific period of time (usually seven to nine days) to get a fixed amount of rate. The advantage is that this method typically offers a higher rate of interest.
- Flexible lending that is very similar to a savings account. This method allows you to withdraw your assets at any time, so the rate of return is usually lower.
Every crypto investor should understand that cryptocurrencies are extremely volatile. Therefore, the amount of interest that you'll earn may vary from time to time. Crypto lending is highly attractive for investors who want to hold their assets in the long term and earn passive income. However, the change in the price of the crypto would give an immediate impact on the revenue. Please consider the asset's volatility before investing as you won't be able to exchange the assets that are locked up in a lending program.
How to Calculate APR
Here's how you calculate APR in crypto investments:
n = the loan period (in days)
How to Distinguish APY and APR Easily?
That being said, APY and APR are not the same. The first difference lies in the function. APY generally refers to the total interest earned, whereas APR refers to the interest that needs to be paid. APY is a percentage rate of the total amount of interest earned on a specific investment based on a fixed interest rate for one year. Meanwhile, APR is a percentage rate that reflects the cost of credit in a year.
Which One is More Profitable?
Both APR and APY can be profitable in their own way, so the answer mostly depends on whether you are an investor, a lender, or a borrower.
As an investor or a lender, you would want to get the highest interest rate possible. In this case, the compounding effect in APY is considered more profitable because it can offer a higher yield. This means that you will earn interest on interest and you can add the extra profit to the initial sum of investment.
Meanwhile, as a borrower, you should pay off the balance as time goes by, so you should look for the lowest possible rate. In order to minimize the interest that you should pay, it's better to avoid compound interest and stick with APR. This concept works in various cases, including personal loans, credit card debt, and crypto loans.
The most important thing is to make sure that you choose the best program to your advantage; legit and offers the best interest for you. Also, always pay attention to the type of interest that the platform offers because some of them might present the yields in APR, while others might use APY.
Understanding the difference between APR and APY is important for crypto investors to manage personal finances, both in the form of savings accounts and investments. Since each platform offers different rates of interest, it's highly recommended to compare several platforms before deciding to invest.