APR (annual percentage) and APY (annual percentage) are key terms used in calculating interest rates for various cryptocurrency investments or loans. Investments can include providing funds to exchange liquidity pools, staking, yield farming, crypto savings accounts and more.
Some of these investments may pay you interest based on the APR, while others use the APY method to calculate the payment. Every cryptocurrency investor should know the difference between APR and APY to allocate funds to the most profitable sources of income.
What is the APR?
Many people are familiar with the interest rates paid on savings accounts or charged on loans by traditional financial institutions. For example, if you get a 5 percent annual interest rate, your $100 investment will yield $5 in profit exactly one year after your investment. However, if you borrow $100 at the same interest rate, you have to repay the loan amount plus $5 in interest after one year.
This simple interest calculation is based on the APR. The real annual interest rate, or annual interest rate, in both the traditional banking and cryptocurrency worlds, indicates the normal rate of interest charged on the principal of an investment or loan. It does not take into account the concept of compound interest, which we discuss in this article.
The real annual interest rate is an annualized figure. If the investment or loan is held for less than a year, interest is applied pro rata. For example, on a six-month investment with a 5 percent effective annual interest rate, you earn exactly half the interest on the principal, 2.5 percent.
Let’s say you invest 1.0 Ether in a loan pool on a decentralized finance (DeFi) platform to earn interest, and the APR is 24%. Putting your money in the pool for exactly 365 days will increase your total investment to 1.24 Ether. This includes your principal of 1.0 Ether and 0.24 Ether (based on a 24% APR) accrued as interest.
What is API?
APY, or annual percentage rate, is an interest measure applied to an investment or loan that takes into account the interest or interest rate. The interest can be increased at any time – continuously, daily, weekly, monthly or annually. The inclusion of compound interest complicates the APY calculation because it takes into account the number of periods, then adjusts the amount based on the interest rate.
How compound interest works
Through regular recalculations, compound interest increases the final amount compared to interest based on simple annual interest.
So, the same initial investment (1.0 Ether) over the same period (1 year) at the same quoted interest rate (24%) yields a final profit of 1.24 Ether per APR and 1.2544 Ether per APY. As you can see, as interest rates rise, your APY will increase over time relative to your APR.
The greater the number of compounding periods used during the investment period, the higher the final amount will be. For example, if your annual investment of 1.0 Ether with an APY of 24% is compounded monthly, i.e. 12 times during the investment period, your final profit would be as follows:
[1.0 ether × (1 + 0.24/12)12] = 1.2682 ether
Difference between APR and APY
Capitalization is the only difference in calculating APR and APY yields. Other things being equal (initial investment, quoted interest rate, investment period), the APY always results in a higher ending amount.
In practice, this means that if you borrow money, it’s best to do so through the APR. On the other hand, if you invest money, APY rates will give you a higher total return.
Where are APR and APY used in cryptocurrencies?
In traditional finance, APR rates are widely advertised, particularly with loan products, while APY rates are more commonly used to market certain investment products. In the cryptocurrency world, both APR and APY are widely used in DeFi protocol, centralized exchanges (CEX) and other finance related crypto platforms in various lending and lending options, liquidity pools, staking services, income structures and even more. Most major DeFi and centralized crypto finance providers have products with APR and APY rates.
APR vs APY in Crypto: Which is Better?
Obviously, APR is better for borrowing while APY is better for investing. The compound effect can work wonders for you when investing in cryptocurrencies for returns.
For example, the Bybit Savings product line allows you to wager a variety of popular coins with interest paid APYs in a low-risk guaranteed withdrawal environment. You can choose between a flexible or a fixed investment period. The platform currently offers an APY of 5% and above for some stablecoins. These are the highest APY rates in the industry for stablecoin investments.
Variable vs fixed APR and APY
Fixed rate options apply the advertised rate throughout the life of the investment, while floating rates vary according to market conditions.
To take off
The cryptocurrency industry offers a wide range of investment and credit options based on APR and APY rates. Due to the nature of the cryptocurrency market, APR and APY rates are often several orders of magnitude higher than in the traditional financial sector. This opens up more lucrative income opportunities, but also comes with greater risk.
When you invest or borrow based on these rates, make sure you understand whether you’re earning or paying based on the APR or APY. If the latter, pay particular attention to the interest period associated with your investment or loan.