APR vs APY Difference: APR (Annual Percentage Rate) and APY (Percentage Annual Return) are important concepts when calculating interest on a variety of crypto investments or loans. Investing may include transferring funds to liquidity pools on exchanges, staking, yield farming, crypto savings accounts, and other activities.
Some of these investments may pay you interest based on the APR rate, while others calculate payout using the APY method. In order to allocate your funds to the most profitable revenue streams, every crypto investor needs to understand the difference between APR and APY.
What is APR?
APR is used in this simple interest rate calculation. APR or Annual Percentage Rate refers to the ordinary interest applied to the principal amount of an investment or loan, be it in traditional banking or in the crypto world. It ignores the concept of compound interest, which we will discuss in this article.
APR stands for Annual Percentage Rate. If an investment or loan is held for less than a year, interest is prorated. A six-month investment with an APR of 5%, for example, will earn you exactly half the interest, or 2.5% of your principal.
Suppose you put 1.0 Ether into a loan pool on a decentralized finance (DeFi) platform to earn interest, and the APR is 24 percent. Leaving your money in the pool for 365 days will increase your total investment to 1.24 Ether. This includes your 1.0 Ether principal plus the 0.24 Ether interest (based on an APR of 24 percent).
APR is a fairly simple interest rate concept. The basic formula for calculating a grand total based on the APR is as follows:
A = [P × (1 + R×T)]
Where
A: Total final amount
P is the principal amount, i.e. the initial investment or loan amount.
R: interest rate used
T : time in years
Using our 1.0 Ether investments, the numbers in the formula are:
1.0 ether (1 + 0.24×1) = 1.24 ether
An investment period of exactly one year is assumed. If you hold the investment for three months, which is a quarter (0.25) of a year, then the formula is:
1.0 ether [1 + (0.24 × 0.25)] = 1.06 ether
What is APY?
APY, or Annual Percentage Return, is a return on an investment or loan that accounts for compound interest or compound interest. Compound interest can occur at any time, constant, daily, weekly, monthly or yearly. Compound interest complicates the calculation of APY because it takes into account the number of periods in which the amount is adjusted based on the interest rate.
The following is the formula to calculate the final amount based on APY:
A = [P (1 + R/N)N]
Where
A : Total final amount
P : Capital, ie the initial investment or loan amount
R : interest rate used
N: number of compounding periods
The N value – the number of compounding periods is the most important part of the formula. It is the distinction between APY and APR. The number of compounding periods refers to how often the investment amount is recalculated using the quoted nominal interest rate.
The interest is added to each recalculation to an amount that includes the initial investment plus any previously accrued interest income.
Suppose you invest 1.0 Ether for one year at an annual rate of 24 percent and your investment has two recalculation periods: 6 months and 12 months.
The numbers in the APY formula in this scenario are:
[1.0 Ether × (1 + 0.24/2)2] = 1.2544 ethers
APY vs APR: Key Differences
While the APR is the amount that must be paid as interest, the APR describes the amount of interest earned over the course of a year. When comparing APR and APY returns, the key difference is compound interest, as all other elements — including principal amount, interest rate, and time period — are the same.
It represents total return, which includes interest and investment income. The APY always returns a larger amount because the APR ignores compound interest. In addition to funding liquidity pools on exchanges, cryptocurrency owners can store their coins in savings accounts, stake their coins, or invest in yield farms.
Also read: Ripple VS SEC: Will the SEC reach an agreement with ETH? XRP Lawyer drops notice
In order to understand where money is best invested, it is important to understand the difference between APY and APR. In practice, borrowers benefit from annual percentage rates. However, in order to maximize their profits, investors should consider APY rates.
Investors need to use manual compounding where they have to reinvest their profits daily or weekly to get a higher compound interest rate as more DeFi tools and cryptocurrencies use APRs.
Where are APR and APY used in crypto?
APR rates are commonly advertised in traditional finance, particularly for credit products, while APY rates are more commonly used to market some investment products. Both APR and APY are commonly used in the cryptosphere for a variety of lending and borrowing opportunities, liquidity pools, staking services, yield farms, and other finance-related crypto platforms including DeFi protocols, centralized exchanges (CEXs), and others. The vast majority of centralized and large DeFi crypto finance companies offer products with APR and APY rates.
What’s better in crypto? APR or APY?
APR vs APY: Of course, APR rates are more beneficial when borrowing money, while APY rates are better when investing. If you invest in cryptocurrency for returns, the power of compounding can work wonders for you.
For example, the Bybit Savings suite of products allows you to stake a variety of well-known coins with interest paid in APY in a low-risk, payout-guaranteed environment. Both flexible and limited investment periods are available. For some stablecoins, the platform currently offers an APY rate of 5% or higher. These APY rates for stablecoin investments are among the highest on the market.
Also Read: Crypto Tax India: 1% TDS on Crypto in India, How to Calculate Your Crypto Tax
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