Understanding APR and APY: A Guide to Choosing the Best Returns for Crypto Investors

In the crypto and digital finance industry, two terms that often confuse beginners are APR (Annual Percentage Rate) and APY (Annual Percentage Yield). Although they seem similar, the difference between the two has a significant impact on the income you will earn from investing or lending digital assets.

What is APR: The Basic Interest Rate

APR stands for Annual Percentage Rate, which is the simplest calculation in the world of finance. If you invest 100 units at an APR of 5%, it means that at the end of the year, you will have a total of 105 units (Principal 100 units + Interest 5 units).

APR does not account for compound interest, meaning interest is calculated only on the principal amount, not on accumulated interest from previous periods.

Types of APR to Know

Fixed APR (Fixed APR) In this case, the interest rate remains unchanged throughout the investment period. The amount you earn each year is always the same. For borrowers, this is advantageous because it allows clear repayment planning.

Variable APR (Variable APR) Interest rates fluctuate based on market conditions and the lending platform’s policies. If the market is volatile, the APY may increase or decrease, adding uncertainty for borrowers.

APR in Cryptocurrency

In the crypto world, APR refers to the total interest earned from staking or lending tokens over one year. Calculating APR in crypto is straightforward because there are no hidden fees.

For example, if you invest 1.0 ETH (ETH) in a DeFi lending pool with an APR of 24%, you should earn an additional 0.24 ETH by the end of the year, totaling 1.24 ETH.

What is APY: Compound Interest That Accelerates Your Money

APY stands for Annual Percentage Yield, which reflects the actual return over a year, taking into account the effects of compounding interest.

The meaning of compound interest (Compound Interest) is that you earn interest not only on the principal but also on the accumulated interest from previous periods—“interest on interest.”

APY in Cryptocurrency

In the crypto world, APY indicates the real yield because it considers the frequency of compounding. In some DeFi platforms, compounding occurs daily or even hourly.

Here’s how APR 6% converts to APY depending on compounding frequency:

• Semi-annual compounding: 6.09%
• Quarterly: 6.14%
• Monthly: 6.17%
• Weekly: 6.18%
• Daily: 6.18%

More frequent compounding = higher returns.

Important Note About APR in Practice

When it comes to credit cards, APR is not charged if you pay the full amount by the due date. However, if there is a balance, interest is added at the end of the billing cycle.

Another thing to watch out for is that APR does not include other fees, such as late payment fees or insurance premiums. Therefore, always review the terms carefully before making decisions.

How to Calculate APR and APY

Basic APR Formula

APR = P × T

where:

• P = periodic interest rate (as a decimal)
• T = number of periods in one year

Example: If you save 0.5% per month, the APR is: P = 0.5% × T = 12 months = 6% per year

APY Calculation Formula

Since compounding is more complex, the formula is:

APY = ((1 + r/n)^n - 1)

where:

• r = APR as a decimal (as a decimal)
• n = number of compounding periods per year

Nowadays, you usually don’t need to do this manually because most DeFi platforms display APY directly.

Advanced Calculation Example

Suppose you invest 10,000 units at 5% annual interest:

Without compounding (APR):

• Year 1: 10,000 + 500 = 10,500 units
• Year 2: 10,000 + 1,000 = 11,000 units
• Year 3: 10,000 + 1,500 = 11,500 units

With annual compounding (APY):

• Year 1: 10,500 units
• Year 2: 11,025 units
• Year 3: 11,576.25 units

The difference in the third year is 76.25 units. Over longer periods, this difference grows even more.

APR vs APY: The Key Difference

Why APY Is Usually Higher Than APR

This difference arises from compounding. When you earn interest on interest, your money grows at an accelerated rate. On DeFi platforms with daily compounding, this effect becomes very noticeable over time.

For example, staking on a platform offering 20% APY means your interest is calculated on the increasing balance, resulting in higher returns than simply multiplying the principal by 20% APR.

Applying APR and APY in the Crypto World

( Staking: Saving and Earning Income

Staking is a passive investment mechanism where you “lock” your tokens on a blockchain to support the Proof-of-Stake consensus mechanism and earn interest.

Here, APY is a better indicator because of the ongoing compounding of interest.

) Yield Farming: Earning from Liquidity

In yield farming, you provide tokens to a liquidity pool for others to trade. You earn a share of transaction fees and reward tokens.

APY here can be very high, but risks like impermanent loss must be considered.

Who Should Use APR and Who Should Use APY

Use APR if you:

• Are a borrower (want the lowest rate)
• Want to compare borrowing costs across platforms

Use APY if you:

• Are an investor/saver ###seek the highest returns###
• Invest in staking or lending pools long-term
• Want to accurately compare savings programs

Summary: How Do APR and APY Differ?

APR is a straightforward interest rate without compounding, suitable for understanding borrowing costs easily. APY reflects the real return, considering repeated compounding. When choosing a crypto investment platform, ensure you look at the APY, not just the APR, to get a clear picture of how your money will grow.

The difference between APR and APY may seem small in the short term, but over the long term, this difference becomes very significant. Once you understand this, you can better select investment opportunities aligned with your goals.