APR vs. APY in Crypto: What Are the Major Differences? (2023)

APR and APY are two forms of interest rates. Both are measurements for yields generated by protocols, centralized digital asset lending platforms, and other crypto investment platforms.

Some platforms may use APR, while others work out yields using APY. While they may sound similar, the two interest rates do not generate the same results. This APR vs. APY guide covers the differences between the measures and explains how to calculate investment returns accurately.

What is APR?

APR (annual percentage rate) is the annual yield a lender earns for lending their crypto assets.

Alternatively, you can think of APR as the annual interest a borrower pays on any loan. In other words, it’s the price you pay to borrow money, as per the U.S. Consumer Financial Protection Bureau’s definition.

Traditional financial institutions apply APR to mortgages, credit cards, car loans, and other types of credit. Within the crypto space, APR is applied to staking, crypto savings accounts, and lending and borrowing with crypto assets. Generally, APR is used for things that cost people money but may also appear in products that make people money, particularly in the crypto space.

While APR is an annualized rate, borrowers often pay their loans monthly or more frequently, depending on the payment schedule. Furthermore, since it’s an annual rate, APRs are prorated — adjusted — for shorter periods. So, a 3% APR on a six-month loan means that the loan only comes with a charge of a 1.5% interest rate.

How is APR calculated?

APR is calculated using simple interest but may include fees and other additional costs associated with the transaction. That means you may need to calculate the APR to get the real annual cost of a loan.

The APR formula is as follows:

APR = ((interest + fees/loan amount) / number of days defined in the loan contract)) x 365 days or one year x 100

Now, let’s assume you want to borrow $10,000 worth of USDT from a lending protocol for two years, and the annual interest rate is 5%. The fees for this transaction are $30.

To calculate the APR, first, calculate the interest using the simple interest formula.

Simple interest earned = P x I x T) where:

P = Principal amount

I = Annual interest rate

T = Time period

Going by our example above

P = $10,000

I = 5%

T = 2 years

Therefore, simple interest earned = 10,000 x 0.05 x 2

Simple interest earned = $1,000

With interest, you can proceed to calculate the APR as follows:

APR = ((1,000 + 30)) / 10,000) / 2)) x 1 x 100

APR = 5.15%

Based on this calculation, the annual interest rate may be 5%, but the real cost is actually 5.15% when you factor in additional fees on top of the interest. Similarly, calculating your staking reward based on the APR may not give an accurate figure of what you’ll receive. Why? Because factors like validator commissions, bonded tokens ratio, block minting speed, and token inflation rate may affect the final staking reward.

Types of APR

APRs can be fixed or variable. A fixed APR doesn’t change. On the other hand, a variable APR can alter at any time depending on market conditions and any other factors the lending platform may decide to factor in. As a result, borrowers are likely to pay more interest with a variable APR than a fixed one. This is especially true if market conditions are volatile.

What is APY?

APY (annual percentage yield) is the actual rate of return you earn on an investment. APR takes the effect of compounding interest into account.

While APR is calculated using simple interest, the annual percentage yield (APY) uses compound interest. That means when using APY, platforms calculate interest on the principal amount and the interest accumulated. APY is typically used for things that earn people money. In crypto, this entails staking, yield farming, and also crypto savings accounts.

Effective annual interest rate (EAR) is an alternative term for APY. In TradFi, platforms apply APY to savings, deposits, money market funds, and other interest-paying accounts.

APY calculates the real return on investment since it uses compound interest. Compounding allows an investment to earn interest on interest over time, making APY a powerful instrument to calculate the real return of an investment. However, APY may not include fees.

How to calculate APY

Crypto platforms that offer interest-earning products may compound interest daily, monthly, quarterly, semi-annually, or annually. A platform that is compounding interest more frequently — e.g., daily — will earn investors higher returns.

You can calculate APY using this formula:

APY = ((1 + r/n) ^ n) – 1 where

r = Annual interest rate

n = Number of compounding periods per year

Here’s what the compounding frequency looks like against the number of compounding periods:

So, let’s look at this example.

Imagine you want to invest $1,000 in ether (ETH) on a staking platform with an annual interest rate of 11%, compounded monthly. Here’s the resulting APY:

APY = ((1 + (11%/12)) ^ 12) – 1

APY = 11.57%, meaning an annual interest of 11% compounded monthly will give an APY of 11.57%. Therefore, $1,000 in 1 year will become $1,122.04 should the APY really apply for the given period.

Forms of APY

Just like APR, APY can also have flexible and variable rates. A flexible APY remains the same over the investment period. However, a variable APY will not stay at the original rate throughout the investment’s duration. Instead, it may fluctuate based on market conditions and any other factors the protocol or crypto exchange will factor in.

APR vs. APY: which one should you consider?

The main difference between APR and APY is that the former uses simple interest while the latter utilizes compounding interest. Hence, crypto investors need to focus on APY because it is a more accurate return measurement than APR.

The frequency of compounding is also a measure to consider since it will determine the size of a return.

Besides comparing APR with APY, investors should also examine these factors:

• Associated costs: Consider costs like on-chain transaction fees and the exchange’s withdrawal costs.
• The APR and APY type: APRs and APYs can be fixed or variable. Therefore, ensure you understand the type of APR or APY on offer before taking a loan or investing your money.
• The digital asset’s current performance and future prospects: Attractive APYs and APRs from platforms whose digital assets are posting dismal numbers aren’t worth it. It’s also risky to stake coins with questionable futures. If their prices drop, your investment will lose value as well, and the APY or APR measurement will turn out inaccurate.
• The reputation and size of the platform: Large DeFi and CeFi platforms that are well-established are likely to have better liquidity than small platforms. This is not a hard and fast rule. However, it’s essential to consider this factor before allowing higher interest rates from smaller establishments to tempt you.

APR vs. APY: the (s)takeaway

While APY is generally the better measurement for examining returns on investment, some staking and other interest-earning crypto platforms offer APRs instead. This could throw you off and make it difficult to compare interest rates across different providers.

Some people may also choose the platform offering an APY over another that uses APR. But it’s never that straightforward. A higher APY doesn’t necessarily always generate more interest than a lower APR due to the aforementioned factors. To make a more accurate comparison, convert APRs and APYs using online tools if you know the compounding frequency.

Furthermore, only compare APYs with the same compounding period. That’s because an APY that’s compounding interest monthly isn’t the same as one using a quarterly frequency. This is a crucial tip when choosing the best products. Another important thing to remember is that staking rewards are typically paid in crypto instead of fiat. This means your staking rewards will be subject to price volatility.

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