From APR to APY: Two Letters Every Cryptocurrency Investor Must Understand

Information Volume Warning In DeFi, staking, and encryption savings products, you often see the abbreviations APR and APY. Many newbies confuse them, resulting in incorrect calculations of potential earnings. The distinction is quite simple: APR (annual percentage rate) does not take compound interest into account, whereas APY does. This difference may seem trivial, but over the long term, it can affect your earnings by several thousand.

What is APR (Annual Percentage Rate)

Let's start with something relatively simple. The Annual Percentage Rate (APR) is the percentage you earn from an investment over a year. For example, if you deposit $10,000 on a certain platform and the annual yield is 20%, then by the end of the year you would earn $2,000. The calculation is straightforward: principal ($10,000) multiplied by the interest rate (20%).

According to this logic:

• End of the first year: $12,000
• End of the second year: $14,000
• End of Year 3: $16,000

It looks very tidy, but in reality, very few people can grow steadily at this speed. The reason lies in what will be discussed below.

APY and compound interest: The secret to wealth growth

At this point, the concept of compound interest comes into play. The core logic of compound interest is: the interest you earn will also generate interest.

Suppose that the platform does not settle annually, but settles interest for you every month. Now the situation has changed. Every month, the platform calculates your current balance (including the interest earned previously), and then pays you new interest. This means the money you earn will keep increasing.

Still the same example: $10,000, APR 20%, but if changed to compound interest monthly:

• One year later: $12,429 (earned $429 more than simple interest)

What if we change it to daily compound interest?

• One year later: $12,452 (earned an additional $23)

The difference doesn't seem significant, but looking at a longer timeline:

• The same APR of 20%, compounded daily, will amount to $19,309 after three years.
• Without compound interest, there will only be $16,000 after three years.
• It was off by $3,309, which is no small amount

The higher the frequency of compound interest, the more the final return. Compounding daily will definitely earn more than compounding monthly.

APY is the true annual yield.

APY (Annual Percentage Yield) is used to show the actual returns considering the compound interest factor. If the APR is 20%, with monthly compounding, the corresponding APY is 21.94%. With daily compounding, the APY is 22.13%.

These two percentage figures represent: the actual annual return you can earn after taking the compound interest effect into account.

Summarize the differences between the two:

• APR: Fixed, simple, does not consider compound interest
• APY: dynamic, complex, already includes compound interest

Want to remember this distinction? Just remember that the term “yield” is more complicated (and also more profitable).

How to Compare in Decentralized Finance Products

This is the key point. Some crypto products on the market are labeled as APR, while others are labeled as APY, and direct comparisons can lead to losses.

Assume you are comparing two Decentralized Finance products:

• Product A: 20% APR (monthly compound interest)
• Product B: 21% APY (daily compound interest)

Product B seems higher, but in reality? Product A's APY is 21.94%, making it more profitable than Product B.

Make sure to use the same unit before comparison. If neither is APY, you can convert using online tools. If you know the compound interest frequency, the conversion is very simple.

When comparing two Decentralized Finance products, special attention should be paid to:

• Confirm whether their compound interest periods are the same.
• Sometimes the platform uses the term “APY”, but it actually refers to the number of tokens that can be earned, rather than the dollar value.
• The prices of encryption assets are volatile, so even if your APY is high, if the coin price drops by 50%, you will still incur a loss overall.

The Unique Risks of Encryption Investment

Compared to traditional savings accounts, DeFi products have additional risks to consider:

Price Volatility: Even if the product's APY is 30%, a decline in the price of the currency can wipe out your earnings. For example, if you invest $10,000 in ETH and earn $3,000 in interest over a year, but the price of ETH drops by 40%, you would still be at a loss overall.

Smart Contract Risks: The code of DeFi products may have vulnerabilities or be attacked, which cannot be compensated by compound interest.

Liquidity Risk: Products with high APY often have poor liquidity, and you may face difficulties in withdrawing quickly.

So before choosing a product, besides comparing APR and APY, what is more important is:

1. Understand the operational mechanism of the product
2. Assess the historical security of the project team
3. Only invest what you can afford to lose.
4. Read the terms and risk disclosure

Final Advice

APR and APY may seem complicated at first glance, but essentially one takes compound interest into account while the other does not. Keep this in mind, and you can avoid being misled by false high-yield promises.

When choosing encryption products:

• Always compare using the same standard (APR or APY)
• Understand the specific frequency of compound interest
• Always remember that high returns in the encryption market often come with high risks.
• Conduct thorough research instead of making decisions based solely on a number.

The price of encrypted assets can fluctuate dramatically, and the funds you invest may appreciate or depreciate. Be mentally prepared for potential loss of principal.