The Secret of Compound Interest: Why APY and APR Numbers Look Different

gaslight_gasfeez · 2025-12-21T15:13:42+00:00

In a Decentralized Finance platform, the difference between APY and APR has a significant impact on investment returns. APR does not take compound interest into account, while APY includes compound interest in its calculations. For example, a 20% APR with monthly compounding yields higher returns. Understanding the calculations and risks of both can help investors make informed choices and avoid misjudging returns.

gaslight_gasfeez

2025-12-21 15:13:42

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When you browse various yield products on a DeFi platform, have you noticed that some display APY while others show APR? These two figures may look similar, but they can lead to significant differences in your final returns.

Starting from $10,000, see how compound interest changes everything

Imagine you invest $10,000 on a certain platform with an annual interest rate of 20%. It all sounds the same, but the subtle differences in calculation can lead to astonishing results.

If the interest is not compounded (calculated only once a year), you will receive $16,000 after three years. It's straightforward and monotonous.

But what if the interest is compounded monthly? How much will you have after three years? The answer is that the different numbers will depend on the frequency of compounding.

This is the core difference between APR and APY.

What is APR: The simplest number

The annual percentage rate (APR) is the most basic way of calculating interest - it does not take compound interest into account at all. If you see a product labeled with a 20% APR, it means that the annual interest income is 20% of your principal. Very simple, with no additional yield enhancement.

For our example:

End of Year One: $12,000
End of the second year: $14,000
End of the third year: $16,000

That's it. The annual increase is fixed.

APY is the real story of earnings: the power of compound interest

The calculation method for annual percentage yield (APY) is different. It has taken compounding into account. This is particularly important in Decentralized Finance products, as many platforms offer frequent compounding cycles.

What is compound interest? Simply put, your interest will also earn interest.

Returning to the same example of $10,000 and a 20% APR, but this time with monthly compounding:

End of the first year: approximately $12,429 (not $12,000)

Where did that extra $429 come from? Because every month, the interest generated from the previous month is added to the principal, and next month you will earn interest on this larger amount.

What if it is changed to daily compounding? After one year, you will have $12,452.

Key finding: The higher the compounding frequency, the more money you earn.

From 1 Year to 3 Years: The Exponential Effect of Compounding

This difference becomes more dramatic over a longer time span.

Under the same 20% APR conditions, if daily compounding is achieved, your account will show $19,309 after three years—$3,309 more than the $16,000 calculated simply.

This is the dividend brought by pure compound interest, without any additional capital investment.

How to Measure Digitally: Calculating APY

So how do we know the real annualized yield? This is exactly the purpose of the APY formula.

20% APR combined with monthly compounding = approximately 21.94% APY 20% APR with daily compounding = approximately 22.13% APY

These APY numbers represent the actual annualized return you receive when you take into account the effect of compounding.

Comparing Products in Decentralized Finance: Where Are the Pitfalls?

Many DeFi products mix APR and APY when promoting returns, which may lead investors to make incorrect comparisons.

Assuming you see two staking products:

Product A: Claims 20% APR (monthly compounding)
Product B: Claims 21% APY (weekly compounding)

Directly comparing these two numbers is unfair. You need to convert them to the same standard in order to make a real decision.

In addition, when evaluating DeFi yields, be mindful that the “yields” in APY are usually calculated in the form of cryptocurrency assets, not fiat currency. This means that even if you earn cryptocurrency tokens based on APY, if the price of that asset drops significantly, the value of your account measured in fiat currency may actually decrease.

Recommendations for Choosing DeFi Products

Always convert to the same basis: Make sure to compare APY to APY or APR to APR.
Pay attention to compounding periods: Monthly compounding vs. Daily compounding can lead to substantial differences.
Understand the Risks: APY is the expected return, and the volatility of the crypto market means that the total value of your assets may decrease instead of increasing.
Read the rules: Understand exactly whether the APY in this product refers to cryptocurrency rewards or fiat currency earnings.

Summary

APR and APY may initially seem like just different abbreviations, but they represent completely different philosophies of yield calculation. The compounding effect of interest means that APY is always a higher number (as long as the compounding frequency exceeds once a year). In the era of DeFi, understanding this difference can help you make more informed investment choices rather than being misled by inflated yield numbers.

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