The rising popularity of cryptocurrencies has surged the interest of people in investing in the platform. Making an investment is easy, but calculating the potential costs and returns is difficult. Understanding the two different interest terms, APR and APY is important for analyzing the interest rate of a loan or investment.
Table of Content
- What is APR?
- How to Calculate APR?
- How Does APR Work in Crypto?
- What is APY?
- How to Calculate APY?
- How Does APY Work in Crypto?
- APY or APR, Which is Better?
- How to Convert APR to APY?
- A Quick Comparison Between APR and APY
What is APR?
APR stands for Annual Percentage Rate. It is the annual interest a borrower has to pay back to the lender against the loan they took. Apart from the interest amount, APR includes annual fees and maintenance costs.
How to Calculate APR?
The formula for calculating APR is
APR= [((Fees + Interest/Principal)/n) x 365] x 100
Where ‘Interest’ is the total amount of interest paid, ‘Fees’ is the additional fees other than interest, ‘Principal’ is the amount of loan taken, and ‘n’ is the number of days in the loan term.
How Does APR Work in Crypto?
APR works on the simple interest principle. It is not the annual interest rate, but much less than the annual interest rate. In crypto, an APR is used in defi applications to make people believe that the platform’s interest rate is low, making them borrow funds from the platform. The annual interest rate is a combination of simple and compound interest, which turns out to be a big amount, preventing users from investing in the platform.
APR describes the annualized interest rate that helps a borrower or lender calculate costs and gains associated with crypto staking. APR shows the interest amount required to pay on borrowings in defi applications. In defi protocols, APR measures the gains earned through liquidity and staking assets. Operators can lend their crypto assets to borrowers as loans, and earn return rewards in the form of interest. The amount of interest can be calculated using APR.
What is APY?
APY stands for Annual Percentage Year. It is the amount of interest an investor expects to receive from a Certificate of Deposit (CD), savings accounts, or Individual Retirement Accounts (IRA).
How to Calculate APY?
The formula for calculating APY is
APY = [(1 + r/n)n] – 1
Where ‘r’ is the periodic rate and ‘n’ is the number of compounding periods.
How Does APY Work in Crypto?
APY works on the compound interest principle. Compound Interest increases with an increasing interest rate. An individual earns a certain amount of interest from the initial deposit and additional interest on the earlier received interest. APY measures the rate of interest a person receives as a return on investment.
By calculating the APY, an investor understands whether they get a good return rate on their investment and can compare the different return interests of different investment platforms.
In crypto, APY is measured while lending and offering liquidity. They add the return from the deposit and interest to provide a higher return rate. While staking cryptocurrency, investors utilize APY, they lock up a certain amount of crypto assets and prevent them from being circulated. This increases the demand and the value of the savings account after selling. In yield farming, farmers transfer their crypto holdings from market to market to increase the potential return. To identify the best potential return rates they calculate the APY of the platform.
APY or APR, Which is Better?
APY and APR are not the same, making both better in their own ways. APR calculates the amount of interest a borrower owes to the operator or lender. An APY calculates the amount of returns an investor receives from a deposit, including interest on the deposit and interest on the initial interest.
How to Convert APR to APY?
An APR is converted to APY by using the formula,
APY = (1 + APR/N)N – 1
Where N is the number of periods.
A Quick Comparison Between APR and APY
| Features | APR | APY |
| Purpose | Determines the amount of interest a person owes to the lender for obtaining a loan. | Determines the amount of interest a person receives while investing. |
| Measures involved | Simple interest, closing rate, and insurance. | Simple interest and compound interest. |
| Calculating formula | APR= [((Fees + Interest/Principal)/n) x 365] x 100 | APY = [(1 + r/n)n] – 1 |
| Use cases | Loans and borrowings. | Investment returns, providing liquidity. |
| Rate change | Fixed-rate on loans | Varying rate on investments |
| Factors affecting | Interest rate, fees, number of days of loan. | Compounding periods and periodic rate. |
Final Thoughts
Annual Percentage Yield (APY) and Annual Percentage Rate (APR) are the two interest terms that serve different purposes. An APR measures the rate of interest a person owes while an APY measures the rate of return on an investment. Though both help to analyze the interest rates, an APY offers a clear and precise picture of the interest you earn or have to pay and tells how much your investment grows over time.