APR vs. APY in Crypto Staking & Yield Farming
https://www.youtube.com/watch?v=o53cspVq6pc
Transcript:
Imagine that you have a bank savings account that pays you a yearly interest rate of 20%. Of course no bank will pay you a 20% interest rate, but imagine it for a second. Let’s say that you invested $5,000 in this savings account. So each month you are getting paid $83.3 as interest. Now imagine two scenarios and the first scenario, you withdraw this interest each month, and spend it on whatever you want.
But in the second scenario, you don’t withdraw these returns and you leave them to be reinvested in the savings account each month. After a year, if you try to calculate how much you earned in interest during this year, you will find that in the first scenario, you earned $1,000 which is 20% of your $5,000 invested. So, here you earned the yearly interest rate, which is called the APR.
But in the second scenario, you will find out that you earned $1,096, which is around 21.9% of your invested $5,000. So, here you earned more interest with a higher rate, this higher rate is called the APY, and it comes from adding the interest you earn each month to the original investment, so, in the next month, you earn interest on a larger investment. You may be still confused, don’t worry, watch this video, and you will completely understand the difference by the end.
Welcome to CryptoBee, where we explain cryptocurrencies and DeFi topics in the most simple and beginner-friendly way. In this video, you will know what exactly is the APR, and what is the APY, the difference between them, and finally, we will talk about the fixed and variable interest rates, so, let’s dive in. Let’s begin with the APR.
So, what is the APR? The term APR stands for annual percentage rate, which is simply the interest rate you will get for staking your coins or putting them in a liquidity pool or yield farms. So that is how much these crypto projects are paying you. For example, if the APR is 20%, that means that if you invested your crypto coins for a year in this project, they will pay 20% interest.
And if you invested your coins for 6 months only, then you will get half the yearly interest rate, which will be 10%. And if you invested for only a month, you will get half the yearly interest rate, which will be 10%, and if you invested for only a month, you will get 1.67%. To calculate how much interest will you earn, you simply multiply your investment by the interest rate for the period you want.
For example, if you invested 5000 LINK tokens and you want to calculate how much you will earn in a year, you multiply your investment amount by 20%, which will give you 1000 tokens. To calculate how much you will earn in 6 months, you multiply the 5000 tokens by 10%, which will give you 500 tokens.
And if you want to calculate your monthly returns, you multiply your investment amount by the monthly interest rate, which is 1.67%. So, for example if you started investing in January, you will earn 83.3 tokens by the end of each month, so in a year, you will earn 1000 tokens, which is the 20% APR. But what if you reinvested the tokens you earn each month by adding them to your 5000 tokens investment? What will happen is that in the next month, you will earn interest on your original investment, plus the interest earned in the previous month. So in February, instead of earning interest on just your 5000 tokens,
you will earn interest on 5083.3 tokens. If we multiply that number by the monthly interest rate, we will get 84.7 tokens. So you will get paid 84.7 tokens in interest by the end of February. This reinvestment of your earned tokens is known as compounding, and it is the main idea behind the APY.
In March for example, you will earn interest on 5,168 tokens, so you will get 86.15 tokens by the end of March, and so on, each month the returns are reinvested and added to the original investment. By the end of the year, you will find out that you earned 1096 tokens, which is approximately 21.9%. This 21.9% is the APY.
The term APY stands for annual percentage yield, which is simply the interest rate you will earn if you reinvested your returns. This doesn’t mean the crypto project will pay you a higher rate you get paid the same interest rate but you’ll earn interest on the interest you earned in the previous months so it is like your investment is increasing each time you compound your returns and add them to your original investment and having a larger investment each month means you earn more in the coming months or periods so in crypto when you see a project with a 40% APY, this means that
your returns will be compounded. In the previous example, you were getting paid the interest monthly, so you reinvested your returns only 12 times during this year. If for example, you are getting paid once per day, then you can compound your returns 365 times per year. This is known as compounding periods, which is how many times the returns are reinvested or compounded in a year.
If, for example, your returns are compounded twice a year, then you have two compounding periods, if your returns are compounded quarterly, then you have four compounding periods, and so on. The important point here is that the more frequently your returns are compounded, the higher the APY, and the more returns you will earn.
For example, if you invested the 5,000 tokens in a project with 20% APR for a full year, this is how much you will earn per year if your returns are compounded semi-annually, quarterly, monthly, and daily. As you can see, the highest returns are when your returns are compounded daily.
Some crypto projects compound the returns every 8 hours, some even compound every 2 hours, but usually anything more than daily doesn’t make a big difference, as you can see compounding every 8 hours doesn’t give that much of a difference compared to compounding daily. So, to sum this part up, the APR is the interest rate they will pay you, the APY on the other hand is the interest rate including the compound interest you will earn on your reinvested returns a very important point here is that you shouldn’t compare aprs with apys you should always see how frequently the returns are getting paid and convert the apr to apy this is because you may think that an investment with 45 apy is better
than an investment with 40 apr butR. But actually the 40% may be better if you can compound its returns. If the returns are compounded monthly, this 40% APR is now 48.21% APY. And if you compound the returns daily, then the APY is 49.15%. In both scenarios it is higher than 45%.
So, you should always see if you can compound the returns, and then convert the APR to APY, which you can do easily using many online calculators. We will actually leave a link in the description for an easy to use one. Another point here that is worth mentioning is that the returns in any liquidity pool, yield farm, or any crypto project are paid in crypto tokens, sometimes even tokens other than what you have invested.
So, in most cases, you won’t earn these huge returns at the end of the year. For example, investing 5,000 tokens worth $10,000 in a project with a 20% APR doesn’t mean that you will earn $2,000 in returns yearly. It just means that you will earn 1,000 tokens. These 1,000 tokens may be more or less than $2,000.
It all depends on the prices of the tokens. Before we end the video, let’s talk about the variable and fixed interest rates. So, you may see an APR labeled as variable. This means that the interest rate fluctuates in response to the supply and demand of the token. So you are not guaranteed to earn this interest rate.
But fixed or stable interest rates on the other hand, don’t change for a specified duration, so you are guaranteed to earn this fixed or stable interest rate for a specific duration. This specified duration may be a full year or less. So always check whether the rate you are seeing is fixed or variable before investing, and like anything in crypto, always do your own research before taking any decision.
At the end of this video, we really hope you now know the difference between the APR and the APY.
