You need to know what APR is in the Crypto world

When entering the DeFi platform or considering digital asset investments, you’ll often encounter the terms APR and APY. These two terms appear frequently and can cause confusion for many people. Understanding the differences between them is crucial to making smart investment decisions.

APR vs. APY: What is the most important difference?

Starting with a clear definition, What is APR? Simply put, it stands for Annual Percentage Rate, which is the interest rate calculated only on the principal amount without considering compounding. In contrast, APY (Annual Percentage Yield) includes the effects of compounding interest.

Suppose you see two options:

• APR 6% per year
• APY 6% per year

The numbers are the same, but the returns differ because APY accounts for daily compounding, increasing your gains over time.

Basic understanding of APR

What is APR? In the context of investing or borrowing, it refers to the cost or income expressed as an annual percentage rate. For example, if you borrow 100 USD at an APR of 5%, you’ll pay back 105 USD after one year. However, APR does not include the effect of interest compounding.

In digital currencies, What is APR? It generally means the interest earned from lending tokens or holding tokens in a lending pool, calculated without considering compounding.

Types of APR you should know

There are two main types of APR:

Fixed APR: The interest rate remains unchanged throughout the investment or loan period. You will know exactly how much you will pay or receive annually.

Variable APR: The interest rate can change based on market conditions. On some DeFi platforms, returns may fluctuate daily or even hourly, depending on supply and demand.

How to use APR in staking and yield farming investments

In the crypto world, two main methods utilize What is APR:

Staking: Locking your tokens on a blockchain to earn interest. This applies to Proof-of-Stake networks like Ethereum after upgrades. Staking on Ethereum offers attractive APRs, though the actual returns are often expressed as APY due to daily compounding.

Yield Farming: Providing liquidity to pools on dApps to earn rewards. The APR indicates how much new assets you will receive annually if compounding is not considered.

For example, if you deposit 1.0 ETH with an APR of 24% in a lending pool, theoretically, you will earn an additional 0.24 ETH after a year (not accounting for compounding).

Calculating APR accurately: formulas and real examples

The basic formula for calculating APR is:

APR = (Interest rate per period × Number of periods per year) × 100

Or simply: APR = P × T

Where:

• P = interest rate per period (percentage)
• T = number of periods in one year

Calculation example:

If you invest 10 BTC at an APR of 6% for 1 year:

• Interest earned = 10 × 6% × 1 = 0.6 BTC
• Total amount = 10.6 BTC

If divided monthly at 0.5% per month:

• 0.5% × 12 months = 6% per year (same result)

Note that standard APR calculations do not include fees, taxes, or other investment components.

APY: The real return with compounding

If What is APR is the nominal rate, APY reflects the actual return considering compounding frequency. The difference lies in how often interest is compounded.

The APY formula:

APY = (1 + r/n)^n - 1

Where:

• r = APR (expressed as a decimal, e.g., 6% = 0.06)
• n = number of compounding periods per year

Example: With a 6% APR and different compounding frequencies:

• Semi-annual compounding: APY = 6.09%
• Quarterly: APY = 6.14%
• Monthly: APY = 6.17%
• Weekly: APY = 6.18%
• Daily: APY = 6.18%

Most DeFi platforms compound interest daily, so the APY is usually slightly higher than APR.

Choosing between APR and APY: Investment tips

Your choice depends on your role:

If you’re an investor or lender: Look for higher APY, as it shows the actual yield you’ll receive, including compounding effects. Even if the difference seems small, it becomes significant over large investments or long periods.

If you’re a borrower: APR might be preferable, as it indicates the cost without the effects of compounding. However, always read the full terms, as APR doesn’t include other fees.

Comparison table:

Real-world comparison example

Suppose:

• You invest 10,000 USD at 5% annual rate
• Over 3 years

Using APR only:

• Year 1 interest: 500 USD
• Year 2 interest: 500 USD
• Year 3 interest: 500 USD
• Total interest: 1,500 USD
• Total amount: 11,500 USD

Using APY with annual compounding:

• Year 1: 10,000 × 1.05 = 10,500 USD
• Year 2: 10,500 × 1.05 = 11,025 USD
• Year 3: 11,025 × 1.05 = 11,576.25 USD
• Total interest: 1,576.25 USD

The difference of about 76.25 USD becomes more significant with larger investments or longer periods.

Risk considerations

Before deciding based solely on APR or APY, consider:

• Platform security
• Future changes in APR/APY, especially in high-yield farming
• Risks like impermanent loss in liquidity pools
• Inflation and crypto price volatility

Higher returns often come with higher risks.

Summary

What is APR? It’s a key financial term in crypto, and understanding it helps you choose the right platforms. APR shows the interest rate or cost without considering compounding, while APY accounts for it, providing a more accurate picture of your actual returns.

For crypto investors involved in staking or yield farming, knowing the difference between APR and APY is essential for developing effective strategies and maximizing profits over the long term.