APY vs APR, know their differences before investing

Greetings to all and sundry on this great platform, I am here once again to write and share with you all another crypto-related article. As promised earlier, I will be fully back in this community after we are done with the project and defend as well. In about a week or two, we shall end all these struggles for a degree. Today, I will be tackling APR and APY as my topic for this article. In this article, we shall look at the definitions for each of them and also look at the differences between these two crypto terms. Without much ado, let’s dive into today’s topic.

APR which is an acronym for Annual Percentage Rate is a term that is widely used to measure the interest rate on an investment or a loan. This term is used in traditional finance by investors and traders. As the name suggests, it is expressed in percentage and gives an interest rate annually over a fixed period of time. Simply put, we say that it refers to the interest rate of an investment that doesn’t involve compounding.

Annual Percentage Rate is usually or commonly associated with decentralized finance (DeFi), yield farming, lending, and borrowing platforms. Users are able to lend their assets to others in order to earn interest payments or even provide liquidity pools for the exchange of interest. The APR on such platforms helps users understand the rate at which their investment would breed interest over a specific time.

For instance, let’s say I decided to lend $2,000 worth of BTC on a particular lending platform that offers an APR of 15%. This indicates that I would be expecting an interest of $300 over the course of a year on my investment without any compounding. There is a formula for calculating that and it is given as follows:

Interest earned (APR) = Principal x (APR/100).

Now, let’s look at APY and what it’s all about too.

APY on the other hand is also an acronym that represents Annual Percentage Yield. This involves the provision of a more comprehensive returns of investment by including compounding. As we saw in APR which doesn’t consider compounding but only considers the simple interest rate, APY takes into account the reinvestment of the interest earned. As such, it helps to provide a more comprehensive understanding growth potential of one’s investment over a specified period.

Annual Percentage Yield is used in the crypto ecosystem to represent interest that is obtained from liquidity mining, staking, and other yield-generating activities on the lending platforms. APYs are earned through the provision of liquidity pools or by locking up your assets in order to earn interest in return. The compounding frequency is very important when calculating APY. This is because it helps to determine how frequently the interest or return has been used in reinvesting to increase the growth of the interest. This also has a formula in calculation and it's given below.

Interest Earned (APY) = Principal × [(1 + (APY / 100)) ^ n – 1]

Where:
The principal is the initial amount invested.
APY is the Annual Percentage Yield.
n is the number of compounding periods within the year.

For example, let's say I decided to stake $2000 of ETH in an ETH staking pool that provides an APY of 10% with a daily compounding. From the formula provided above, after a year, the following can be deduced;

Interest earned (APY) = $2000 x [(1+ (10/100)] ^ 365 – 1]
It is observed that interest earned is higher when compared to the APR.

These two crypto terms or tools enable investors to assess the potential interest in their investments. As we stated earlier, APY involves compounding frequency which provides a much better representation of the potential growth returns of their investment, whilst APR doesn't involve any compounding frequency. It is good for an investor to consider investment opportunities based on APY instead of APR. Moreover, one must make sure to research more to learn the difference between the APR and APY and know which one best suits his investment strategy. Remember, that there are risks involved in every investment, and one must do your own research (DYOR) before taking considering any investment opportunity.

Thank you all for your time and attention in reading this post.
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