APY, which stands for Annual Percentage Yield, means the actual annual financial earn a person will generate through investment as a real rate of return. With APY, a user is to get the real earnings of investment annually, taking into account all compounded interests in a year.

However, it should be stated that, compared to simple interest, compounding interest is measured based on a period to add to the balance. The account balance increases slightly with each calculation, which means the interest for the balance increases. 

KEY TAKEAWAYS:

  • Annual Percentage Yield is a real-annual-earn an individual will acquire via investment as a real rate of return.
  • APY is mostly used by investment companies with the aim of attracting more customers.
  • An investor can earn more returns based on the initial investment amount via APY.
  • Some of the DeFi markets also offer APY through the block rather than a periodic base.

How to Calculate APY: The Formula

Often used by investment companies to attract investors, APY provides a more significant return, especially in long-term services such as private pension and savings accounts. So how? While calculating the APY interest, the interest rates during the year are also taken into account. Here is its formula:

the formula of apy

Where:

  • r is the period rate
  • n is the number of compounding periods

Example of an APY – How to Earn APY on Your Crypto

Let’s make the APY clearer with a very simple example. Imagine a traditional finance bank like HSBC offering a savings account with 15% interest. Let’s also assume that the bank offers returns on simple interest only and does not touch your principal amount. So, if you start with a $200 deposit, you’ll have $230 at the end of the year. This is $30, or 15%, which will be added to your starting amount of $200.

Compound interest with vs. APY: What is the difference?

So, what if you would find yourself in a situation where you cannot choose compound interests or APY? They are both based on compounded earn logic but with a little difference. Let’s make a little comparison! 

Many banks offer compound interest accounts to their users. The interest calculated for each specified period (such as three months or six months) is added to the principal with compound interest.

Considering this, a bank may offer a savings account with a six-month interest rate of 10%, which means that the interest will compound every six months. If a bank user invests a $100 deposit, they will have $110 at the end of 6 months. 

However, after that, $110 becomes the principal amount and will be used as principal, after which the total balance will be $120.5.

The Role of APY: Determines the Profit of Investor

Regardless of the type of investment, the main goal of all investments is how much profit the investor will receive at the end. APY provides a return on an annual basis interest. The period is fixed (12 months) and will provide returns according to the initial investment amount. So why is this important?

An investor can get more accurate results by considering the effects of compound interest by comparing rates of return, as we mentioned above, by the percentage of each over a year. Remember that the more frequent the period, the faster the investment grows and the more profits it will return.

It is, therefore, very important to know how often the compound rate is added to the principal since the following interest payments are calculated on that larger principal amount.

APY vs. APR: What’s The Difference? 

The APY is the annual interest earnings, based on fixed principle money all year. The APY provides profit through the simple interest rate and compound interest. As a result, the return becomes the annual principal’s interest with added interest on your earnings. 

However, the APR, the annual percentage rate, is the yearly cost of your borrowing, the actual annual cost of funds over the term of a loan on an investment. It is the simple annual interest you will earn.

To highlight the differences between them in a nutshell:

  • APR is the annual rate calculated to earn or borrow money.
  • APY takes compound interest into account, while APR does not.
  • Compound interest differs from simple interest in that the daily interest rate is multiplied by the number of days between payments.
  • Investment companies offer APY, while lender companies advertise APR.

Understanding APY in the DeFi Markets

In DeFi, APY periods are calculated using blocks listed on the blockchain, which means the compounding rate in DeFi markets is smaller than in traditional markets due to the high numbers of blocks. However, the overall return profit can still be quite efficient since compounding takes place again and again. 

Let’s say that a DeFi protocol offers an annual interest rate of 6%. In this scenario, the compound interest rate per block is calculated by dividing 6% by the total number of blocks published on the blockchain in one year. 

Also, the methods used in calculating APY differ depending on the application protocol and the blockchain network.

Explore crypto saving accounts offer the best APY rates!

What is APY?

APY is the actual return earned in one year while the interest is compounded during the period.

What is APR?

The annual percentage rate, APR, is the annual cost charged for a loan or money earned by an investment. 

What Is the Difference Between APY and APR?

APY calculates the rate earned in one year through a compounded interest and gives the actual rate of return. APR, on the other hand, includes any costs linked to the transaction without compounding interest within a period. 

What is a good APY rate in traditional finance?

In the USA, as the Federal Deposit Insurance Corporation (FDIC) states, the national average APY on savings accounts is around 0.07%. However, most banks offer more than that. 

How is APY calculated? 

APY is calculated through the interest rate and the number of compounding periods within a year.

What is good APY for crypto?

In the crypto world, decentralized platforms can offer much higher APY rates through their native tokens. Centralized platforms, on the other hand, offer lower rates compared to them. Still, the situation is quite good when compared to the interest given for fiat currencies. In the cryptocurrency world, higher APY rates are always offered for stablecoins than others. For example, while the rates for coins such as Tether and DAI vary between 8 and 12 percent, these rates vary between 1 and 8 percent for cryptocurrencies such as Bitcoin and Ether.