APR vs. APY: What’s the Difference?

APR vs. APY: What’s the Difference?

APR (annual percentage rate) and APY (annual percentage yield) are terms used in finance, including crypto, to describe how loans and investments change in size over time.

APR and APY concern interest on loans and investments, and apply to activities such as staking in crypto just like they do to traditional borrowing and lending.

What is APR?

APR (annual percentage rate) refers to how much interest accrues on a given investment over a one-year period.

When one party loans funds to another, for example a crypto investor to a staking pool, that lender requires an incentive. This often comes in the form of interest, and APR is used to determine how much ‘extra’ the lender will receive once the loan is recalled.

APR can vary over the course of the year or relevant period, but does not take into account so-called ‘compounding’ — the percentage return is based on the amount initially pledged. 

For example, a 100 ETH loan with 5% APR will yield 5 ETH after one year, giving the investor 105 ETH. If the investor loans out their funds for another year, 5% APR will apply only to the initial investment, not the initial 100 ETH plus the first year’s interest. As such, after year two, the investor will have 110 ETH.

The example above is covered in the formula for calculating APR, which looks like this:

APR does not oblige a borrower and lender to interact for strictly one year at a time. It is an “annualized” figure — staking 100 ETH for six months at 5% APR, for example, will yield 2.5% gains, or 2.5 ETH, when time is up. This is referred to as the ‘pro rata’ basis for interest calculation.

What is APY?

APY (annual percentage yield) is similar to — but not the same as — APR.

APY generally applies to what borrowers need to pay when they take out a loan, as it manages ‘compounding’ — essentially a form of paying interest on interest.

The math behind this is more complex, as the amounts involved change with every payment deadline. The formula for APY is as follows:

Example of APY

For example, 100 ETH borrowed at 24% APY will yield different sums at the end of the year depending on the number of compounding periods, or how many compounding events take place.

With 24% non-variable APR, the final amount would be 124 ETH. With APY, however, compounding the loan once after six months and again after the full year is up would mean that interest is added to the interest twice.

This gives a total of 125.44 ETH after one year — more than 24% APR. If the loan were to be compounded more often, for example monthly, the final amount would be higher still — 126.82 ETH.

The above calculation shows why it is important to take note of terms and conditions when borrowing, whether in crypto or elsewhere. Compound interest can quickly increase the overall amount due at the end of the loan period.

The picture is additionally complicated thanks to crypto markets’ inherent volatility — particularly applicable to the kind of tokens used in DeFi staking. Because of this, APR and APY rates are commonly variable, meaning that they change throughout the year based on liquidity and overall market conditions.

In practice, variable interest rates mean that more money will likely be paid to cover a loan, and thus it pays to understand whether a given agreement is based on fixed or variable APY.

Is Crypto Staking APY Profitable?

The conditions crypto investors encounter when it comes to interest can be highly volatile — as volatile as the underlying asset itself.

This is one of the many allures of staking in DeFi — the fast-paced environment allows staking farms and pools to offer very high, even extreme, APR and APY rates. Locking funds in a pool for a year can potentially earn an investor a considerable premium on their initial capital pledge.

However, with increased rewards comes increasing risk. Volatility can impact liquidity, and fluctuations in market value can turn a long-term staking deal into a liability rather than an opportunity.

This scenario can reach absurd proportions. For example, what appears to be the stake of a lifetime at 500% APR can end up worthless if the token involved sees a rug pull and its value drops 99% overnight.

A way to minimize the risk of such an event is to stake on trusted platforms with a longer proven track record. These will have both better security and more reliable liquidity conditions.

To find out more about how bad actors can impact DeFi token markets, see the TabTrader Academy articles on rug pulls and sandwich attacks.

Where to Find Crypto APR and APY rates

When staking, reputable DeFi platforms will list the APR or APY rates as part of the offer, making the applicable interest visible immediately.

APR and APY are not just used in staking, however. Crypto lending platforms also leverage interest as part of their product, as do crypto-based savings accounts, debit and credit cards.

Conclusion

APR (annual percentage rate) and APY (annual percentage yield) are essential components of financial lending, and crypto also makes widespread use of them.

When staking, taking out a crypto-denominated loan, providing liquidity to a loans platform or using a crypto credit or debit card, it is likely that APR and/or APY will be part of the process.

APR and APY show the conditions of interest applied to a loan or staked capital — something which is essential to understand when calculating income or the total amount due for repayment in the future. APR calculates interest differently from APY over time, and knowing the difference in advance is important.

Simply knowing how interest works in crypto might not protect you from the DeFi’s notorious volatility, however. A token involved in a loan or staking operation may experience such wild and rapid changes in value that the interest may render the entire pursuit unprofitable — or worse.

Due diligence is thus required when considering any form of crypto lending or borrowing. Reputable platforms have emerged in recent years as part of the constant expansion of the DeFi industry, making it increasingly easy to avoid some of these classic pitfalls.

 TabTrader offers the world of DeFi trading from one go-to terminal. Thousands of tokens on the world’s biggest and most reliable exchanges at your fingertips to trade 24/7. Ready to see how crypto trading is being revolutionized? Head to the website and try the TabTrader app for iOS, Android and Web.

If you are new to crypto and want to know more about tokens, exchanges and how to trade, the TabTrader Academy has the answers to all your questions.

FAQ

What is APR vs. APY?

APR (annual percentage rate) and APY (annual percentage yield) both refer to methods of application of interest, but calculate it differently. APR refers to interest applied over a sum of cash or crypto. It is annualized, so will be less in the event that the interest accrual period is under a year. APY ‘compounds’ interest, meaning interest is paid on previously-applied interest, and the total depends on how often interest is compounded per year. 

What is APR and APY in crypto?

Crypto treats interest in a similar manner to any other realm of finance — APR and APY can be applied to all manner of investment products and services. Often, DeFi platforms will list the relevant interest terms in APR or APY upfront as part of a listing.

Is a higher APR or APY better?

Interest rates can be highly advantageous, but higher does not always mean better. Naturally, if taking out a loan, a borrower will look for the lowest possible interest rate in order to repay less at the end of the borrowing period. Likewise, attractively high rates for staking or loaning out funds may come with a catch — extreme volatility in the token involved, which can create a nightmare for the exposed party.

What does 10% APY mean?

If a crypto product, for example a loan, is advertised as having 10% APY, this means that 10% interest is added to the original amount per year, but will be more depending on how many so-called ‘compounding’ periods there are in that year. Compounded each month, interest will be added to the total 12 times, increasing the total amount due. 

Crypto APR and APY: What’s the catch?

Conditions for lending or borrowing in crypto are made clear on the more reputable DeFi platforms. However, when calculating the true financial implications or a specific agreement, it is important to factor in associated costs such as fees, as well as volatility conditions. Just like traditional finance, meanwhile, crypto credit and debit card providers can be sneaky as to how they advertise usage fees and interest rates.