For every investor, the yield number is important. It creates passive income out of the assets that they hold in the hope of future growth. After buying the crypto assets, crypto newcomers or even veterans will do something besides putting them into storage. Investors can join DeFi products such as lending, staking, or yield farming to get returns.
In this article, we will dive deeper into the two terms APR and APY which reflect the expected returns of the investment. Let’s rock them.
What is APR?
Annual Percentage Rate (APR) refers to the annual interest in a percentage number of a loan or an investment. It is the amount of interest that a borrower has to pay annually after taking out a loan. Furthermore, if you are an investor, APR shows how big the reward you will receive. In the crypto space, users are attracted to high APRs given by DeFi platforms.
For further information, an APR excludes compounding interest. This means that the interest is not automatically reinvested in the initial investment.
How to calculate APR
Service providers (lending/borrowing or staking) decide the APRs on their platforms for users to view. Although APR is calculated on a yearly basis, a borrower can pay the interest monthly. The monthly amount is calculated by the amount of interest generated in a year divided by 12. The calculating process is the same as the rewards given to users.
Types of APR:
- Fixed APR: As its name suggests, it is a fixed number of annual interest. For example, a borrower has to pay an APR-based amount of interest to the loan owner after a period of time.
- Flexible APR: Depending on the terms given by the platform, the APR can be flexible because the platform fees and the interest rate might change. Crypto assets are high-volatile and the total value can be up or down drastically in a short period of time. Therefore, if the value of the deposit/collateral changes, the APR might be adjusted by the service provider.
For example, on Binance Earn, investors can select either fixed or flexible investments. In the fixed investment, they will receive earnings with an APR of 5%. In the flexible investment, Binance gives a 1%-10% interest rate on the initial investment to its users. Users should understand every investment strategy before investing capital.
What is APY?
Annual Percentage Yield (APY) refers to the rate of return on the investment over the course of one year. Similar to APR, APY decides the amount of the reward investors receive after a period of time. In addition, APY includes compounding interest, meaning that the generated interest is reinvested regularly in the principal amount (initial amount) to generate more interest.
When the interest is being compounded, the APY is often bigger than the APR. But the rate inherently depends on the platforms. It can vary according to the current value of the assets and other factors such as gas fees, platform fees, or the investment strategy.
Differences between APR vs. APY
The core difference between APR and APY is with or without the compounding strategy. APR does not include compounding while APY holds it. Therefore, we often see APYs are bigger than APRs.
The compounding effect can create huge impacts on the investment in the long term. Albert Einstein, a theoretical physicist, stated that compound interest is the 8th wonder of the world. If we understand the working principle of compounding, we will be able to generate wealth.
Where does the yield come from?
Investments with either an APR or an APY give investors substantial returns over time. The interest might come from the project or its investors. In the following sections, we will dive deeper into the rivers of yield to understand what is behind those numbers.
In the crypto market, the founder team can have allocations for the development of the project. Furthermore, a portion of the total token distribution to attract new investors is always essential for any project.
Crypto users can participate in yield farming programs to bootstrap the platform liquidity and receive token rewards. However, the high-yield incentives can not last long, investors focusing on yield will leave for yield.
Learn more: What is Yield Farming?
“If you do not know where the yield comes from, you are the yield”
As retail investors, we often see startup projects announce massive liquidity mining or yield farming programs with overwhelming APYs. New investors deposit their crypto assets in liquidity pools in order to receive token rewards in the hope that the token will have value in the future.
A notable example is the 20% APY of UST, the algorithmic stablecoin on Terra. Anchor Protocol on Terra used to offer a fixed 20% APY to investors. The model was unsustainable and it decreased the APY down to 16%. Despite that, it could not save Terra from the death spiral of LUNA and UST. Then the total market cap of LUNA and UST was drained from tens of billions of dollars to under one billion dollars in just a month.
Unfortunate events are always imminent, especially in the crypto market. Therefore, we should always do our own research and implement risk management carefully before jumping into any opportunities.
FAQs about APR vs APY
Should we invest in opportunities with high APRs and APYs?
Our eyes are often attached to every possible opportunity. It might be so tempting to take a look and then take action. But we should be careful since the interest number can be manipulated or rigged.
First, we can make profits out of the high-yield investment.
Next, we might lose more than what we earn because every investment has a certain level of risk.
This is not the only calculator there are also other APY and APR calculators.
Where to find the best APRs and APYs?
Coindix is a data platform that aggregates all DeFi protocols and compares them in various criteria, including APYs.
Staking Rewards is a staking-data platform that shows the potential returns of staking on blockchains such as Solana, Cardano, XRP, BNB Chain, etc.
Above are two platforms we recommend for exploring. At the moment, there are other websites that have similar features. So feel free to discover the crypto space at your own pace.
Understanding what APR and APY stand for will build crypto investors' confidence to go long-term with the market. High-yield opportunities always contain underlying stories that we might not fully understand. Therefore, being cautious investors might help us avoid rigged crypto schemes. To reiterate, we should do risk management to spare ourselves from big mistakes.