Cryptocurrency Annualized Percentage Yield (APY) vs Annual Percentage Rate (APR)

In the past few years, the bank savings interest rate has been on the decline, given the state of inflation. One prominent example is the U.S. Bank Standard Savings account, with an annualized percentage yield (APY) of 0.01% as of 16 April 2023. With such low bank interest rates, people have been attracted by the cryptocurrency market’s passive yields through avenues such as staking, yield farming and cryptocurrency lending.

APY is a common term used in traditional finance, as well as in the cryptocurrency market, to indicate the rate of return gained over the course of a year. The other commonly used metric displayed for users is the annual percentage rate (APR). The main difference between the two lies in whether the returns earned by users are simple or compounded.

This article will explain what APY is, how it differs from simple interest rate and APR, the factors that affect APY and some of the cryptocurrency avenues that involve APY. Understanding APY can aid you in comparing the returns you’ll receive from various investment opportunities.

What Is Annualized Percentage Yield (APY)?

APY refers to an annualized actual interest rate of return earned from an investment, factoring in compound interest that accrues or grows with the balance. Compound interest includes interest earned from the initial deposit, plus the interest earned on that interest. To put it another way, APY is a way to track how interest accumulates over time.

Although commonly associated with traditional savings, APY is a crucial metric for cryptocurrency savings programs and works in a similar way. Cryptocurrency investors can earn APY by staking their cryptos, putting them in savings accounts or providing liquidity to liquidity pools via yield farming. 

You can quickly get started earning APY on your cryptocurrency through crypto exchanges, wallets and DeFi (decentralized finance) protocols.

Typically, investors earn interest in the same crypto that they’ve deposited. However, there are instances where one can be paid in either the same or a different currency.

How to Calculate APY

APY = (1 + r/n)ⁿ – 1

where:

• r = Annual interest rate, expressed as a decimal number (i.e., 10% would be 0.1)

• n = Number of compounding periods per year

• 1 = Baseline that represents investment

However, there are other ways of calculating APY, depending upon the exchange. For example, Bybit offers flexible savings plans that allow users to stake and unstake tokens anytime to collect guaranteed yields without the element of compounding interest. The APY is calculated in a simple interest format, where the daily yield represents the interest rate that will be deposited into your wallet based on the number of tokens you’ve staked. 

The formula is as follows:

Daily yield = Number of total tokens staked × (APY for the staked token ÷ 365)

For example, if you’ve staked 10,000 USDT for guaranteed APY at 9%, you can collect 2.5 USDT the next day. The calculation is represented as 10,000 × (0.09 ÷ 365) = 2.4657 USDT.

However, if you’ve chosen to unstake your tokens after collecting daily yields, no yield will be credited to your account. Essentially, any changes to the initial staked asset will affect your daily yield. 

Stake & Earn up to 120% APY on Bybit

Simple Interest Rate vs. Annualized Percentage Yield

While APY refers to the projected rate of annual return gained on a deposit or stake after compounding interest, a simple interest rate only considers the interest earned on the original stake. 

Compounding is a powerful investment tool since it enables you to earn additional income over time. Compound interest refers to the amount received on both the principal amount and the interest that accumulates over time. With each additional period, the interest paid on the overall balance also increases, since the account balance is increasing.

Rates of return can be difficult to compare across different investments if they have different compounding periods. One may compound daily, while another compounds quarterly or biannually. It’s critical to know how often that compounding occurs, since the more often a deposit compounds, the faster the investment grows

To make it easier to understand, consider staking $1,000 at an interest rate of 12% per annum in January 2021. After one year in January 2022, using a simple interest rate calculation, you’ll receive a total of $1,000 × (1 + 12%) = $1,120.

The same $1,000 staked at 12% per annum, but with biannual compounding of interest in the first six months, will give you $1,000 × (1 + 6%) = $1,060, or the total after six months.

After a year, you’ll earn 1,060 × (1+ 6%) = $1,123.60 

That extra $3.60 comes from the power of compound interest. Therefore, your annualized percentage yield is the return you’ll receive over the year: $1,123.6 ÷ $1,000 − 1, or 12.36%.

How Does the 7-Day APY Work in Crypto? 

The 7-day APY is an annualized yield using 7-day returns. It’s calculated by taking the net difference in price from 7 days ago to today, and generating an annual percentage. 

The formula to calculate 7-day APY is as follows:

APY = (X − Y − Z) ÷ Y × 365/7

Where:

• X = the price at the end of the 7-day period

• Y = the price at the start of the 7-day period 

• Z = any fees for the week

This calculated amount helps investors understand the weekly yield or return. Find out the annual interest yield using the APY calculator here. Note: The crypto APY calculator suggested here may not be accurate, as the calculation is highly dependent upon the terms and conditions of the platform's staking policies and/or the yields.

Does APY Represent Final Earnings?

APY represents your rate of return (the amount of profit or earnings you can make).

Depending upon how long you choose to stake your coins, your ultimate earnings will differ. The holding period will determine how much you actually earn. 

What Is the Annual Percentage Rate (APR)? 

APR, or annual percentage rate, is the interest you earn from your invested assets in a year, expressed as a percentage. This figure may include fees that borrowers pay. It’s a useful tool for comparing different investment products, since it provides a consistent basis for presenting annual interest rate data. 

APY and APR sound very similar. However, unlike APY, APR doesn’t factor in compounding

For example, if you stake 10,000 coins at an APR of 10%, you’ll earn 1,000 coins as interest after one year. But with APY, the situation changes significantly. 

To calculate APR, you can use the following formula: 

APR = [(Fees + Interest) ÷ Principal] ÷ n × 365 × 100 

Where:

• P = principal investment 

• n = number of days in the term

In traditional finance, APR is often used to discuss terms for borrowers — for instance, the credit card interest rate that borrowers pay. This percentage rate of interest can also refer to the percentage paid to investors. In general, the APY for a loan is higher than its corresponding APR because of the effects of compounding.

APY vs. APR

Cryptocurrency assets and activities are usually compounding investments. Instead of simply collecting a flat yield once a year, as in the case of APR, cryptocurrency investments tend to involve reinvestment and make use of compounded interest to help investors boost their rewards. Hence, APR, which is good for flat figures, isn’t too useful when it comes to compounding assets, such as cryptocurrencies. This is also the key reason why most cryptos show APY instead of APR — to provide a better gauge of investment returns.

Another difference is that APR is usually inclusive of all charges, whereas APY only calculates interest rates.

One important note is that because APY includes compounding in its calculation, it will always produce a higher interest rate.

Factors That Influence Crypto APY

Inflation

Inflation refers to the loss in value of a currency over time. Within the cryptocurrency market, inflation refers to the process of adding new tokens to the blockchain network, usually at a predetermined rate. The appeal of cryptocurrencies such as Bitcoin is that they’re designed to have predictable, low inflation rates. 

The rate of inflation for a particular network affects its staking returns. If your coin experiences inflation rates higher than your APY, then your earnings are eroding just as quickly as you’re adding them.

Supply and Demand

As with any market economy, supply and demand influence pricing. An owner of a cryptocurrency can effectively lend it to generate interest income. Since interest is earned based on the demand to borrow that crypto, market dynamics can determine the rates. 

The interest rate charged for borrowing money tends to be lower when there’s plenty of supply and higher when it’s scarce. Similarly, cryptocurrency APY is variable, changing according to the liquidity and level of demand for each coin.

It’s typical of newly launched projects to offer sky-high lending APYs, in order to encourage new users to come onboard and provide liquidity to their token — which will also aid in increasing the demand for the project’s token. However, as time passes, this APY will eventually fall, offsetting the initial, artificially propped-up numbers.

Compounding Periods

Calculation of APY is also influenced by the amount of compounding applied, which can vary. Remember that APY increases as the number of compounding periods increases. 

Let’s look at an example. If you deposit $100,000 compounded monthly at 5% per annum, your APY will be 5.116%. The calculation used is 100,000 × (1 + 0.05 ÷ 12)⁽¹²⁾. Your balance will be $105,116 by the end of the year. 

On the other hand, if compounding is done on a daily basis, then your APY will be 5.126%, with a final balance of $105,127 by the end of the year. The calculation used is 100,000 × (1 + 0.05 ÷ 365)⁽³⁶⁵⁾.

The more opportunities your interest has to grow, the more it can earn. 

Cryptocurrency Investments That Involve APY

If you’re the HODLing type, then you don’t have to just store your crypto in a wallet and wait for it to appreciate. There are ways to invest your cryptocurrency and draw on the magic of compound interest or APY in order to grow and multiply your assets.

Cryptocurrency Lending and Borrowing

If your target time horizon in crypto is for the long term, you can get a lot more mileage out of your holdings with cryptocurrency lending and borrowing.

Cryptocurrency lending works pretty much the same way as traditional lending, except you’re lending cryptocurrency rather than paper money. When you lend out your cryptocurrency on a decentralized platform to borrowers, you earn interest or crypto dividends. Depending on the platform, the interest rates can range from 3% to 17%. This is evidently a larger range compared to the TradFi markets, with interest rates ranging between 4.75% to 5%.

While cryptocurrency lending provides investors with a passive income stream, borrowers also benefit from enjoying additional liquidity. 

Cryptocurrency Borrowing

Let’s say you have 10 bitcoins, and you need some cash urgently — but you don’t want to sell any of your Bitcoin because you believe its value will “go parabolic” in the future. You fear that if you offload your Bitcoin, you could end up with less of it when you repurchase it at a later date, due to an increase in Bitcoin’s price. 

So what can you do?

Cryptocurrency lending platforms will allow you to use your 10 bitcoins as collateral to receive a loan. However, you may be required to over-collateralize, a fancy way of saying you’ll have to lock in far more cryptocurrency than the amount you want to take as a loan. 

When you repay your loan in full, your collateral will be returned. The amount repaid will depend upon the APY of the loan, which determines the interest rate paid. Hence, borrowers will always prefer a lower borrowing APY, as it means a lower cost for them.

Cryptocurrency Lending

Lending platforms connect cryptocurrency lenders to borrowers. Here’s how crypto lending works:

A borrower requests a loan from a lending platform. Once the platform approves the request, the borrower must lock some of their cryptocurrency as collateral for the lending. The lender funds the loan and receives interest payments periodically at the agreed-upon APY. This continues until the end of the loan tenor.

The borrower returns the entire loan amount, and only then is the collateralized cryptocurrency returned.

Participating in cryptocurrency lending is straightforward. First, find a good lending platform. There are two types: decentralized and centralized platforms. Smart contracts run the decentralized lending platforms without any intermediation. In contrast, centralized platforms involve a third party that manages the lending process. 

Before signing up with a lending platform, please do your due diligence to ensure that it’s reputable. Then confirm and compare the APY offered so that you get the most out of your digital assets.

Yield Farming

Yield farming refers to proactively lending your cryptocurrency assets to earn more cryptocurrency. Yield farmers move their assets around to different marketplaces in search of the highest yield, treating the approach as a trading strategy. The most successful yield farmers are constantly tracking APY and taking advantage of the most lucrative opportunities. Yield farmers typically earn far higher rates than they would from saving fiat currencies in the bank.

Be careful before investing in newly launched protocols with sky-high APYs. This could be a strategy to attract customers in the initial phases. The APY could eventually drop drastically, trapping a large number of users and their funds. If you come across a yield farming platform or program offering high APYs, make sure to check its credibility in the DeFi community.

Cryptocurrency Staking

Cryptocurrency staking is a method of earning rewards with your crypto by confirming crypto transactions on a blockchain network. Essentially, you can generate your income on proof-of-stake (PoS) networks that bring stakeholders together to verify the network. Not only are you securing the network, but you earn cryptocurrency in the process.

The more cryptocurrency you commit to the network, the more likely you’ll be chosen as a validator to add blocks to the blockchain. Unlike cryptocurrency mining, you don’t need any special hardware to earn rewards. When you stake, you lock up your cryptocurrency, taking it out of circulation for a defined period. This effectively limits the supply of the cryptocurrency, which can also positively impact its price.

What Can You Do With Earned Interest? 

Earned interest goes into your portfolio as profits earned with relatively little work. This is in fact the definition of passive income. You can keep trying to earn more interest on that income, or you can take the earned interest and use it for trading. The cryptocurrency market is ripe with opportunities to trade spot crypto and derivatives. 

Trading spot cryptocurrency means buying and selling cryptocurrencies at current market rates on an exchange. You can also trade derivatives, which are financial contracts whose value is based on an underlying cryptocurrency. Derivatives contracts, such as futures and options, offer additional ways to access and trade cryptocurrencies.

Of course, you can also take that earned interest and use it as a store of value, as your cryptocurrency is expected to maintain its purchasing power for use at a later date. 

The Bottom Line

Every investor needs methods of comparing investment opportunities and calculating how much profit they’ve made. APY, or annual percentage yield, is a standard calculation of the rate of return used in traditional finance as well as in DeFi and crypto. It includes the effects of compound interest, which can increase the amount you earn. The higher the APY, the more money investors make. Comparing your APY options can help you figure out your most attractive investment opportunities.