If you’ve been looking into decentralised finance (DeFi), you have probably come across the terms APY and APR. These terms are used to denote the type of returns applicable on funds deposited in a DeFi protocol. While the two acronyms sound pretty similar, they have slight differences that can have a substantial impact your returns. Let’s look at how APY and APR work and understand the differences between the two.
Understanding APR
APR stands for annual percentage rate and refers to the interest you receive for locking up your tokens in a DeFi protocol. It is calculated as simple interest and represented as a percentage of the principal amount.
For instance, if you provide 100 tokens to a liquidity pool at an APR of 10 percent, you will receive 10 tokens as interest at the end of one year. It’s easy to understand and even easier to calculate; just multiply the APR with the deposited amount, and you get the returns applicable.
Understanding APY
For instance, if you lock up 100 tokens in a DeFi lending protocol at an APY of 10 percent, the interest is added (compounded) to your principal amount at regular intervals. This ensures that interest is calculated on an increased amount every time, resulting in a larger payout at the end of the deposit term.
The formula for APY is (1 + R/N) N – 1, where ‘r’ is the interest rate and ‘n’ is the number of compounding frequencies in a year.
Understanding the difference
APY works on the power of compounding. It keeps adding the interest earned to the principal amount on a quarterly, monthly, weekly, or daily basis. You do not enjoy this feature with APR, which can significantly affect the return amount over time.
Assume you deposit 10,000 TRX into a DeFi protocol. The platform provides you with a 20 percent APR in return for the liquidity you provide. Therefore, after one year, you will receive 12,000 TRX.
However, if the platform offers you an APY of 20 percent, compounded monthly, you will get 12,193 TRX at the end of one year. That is 193 TRX more in interest earned simply by adding the effect of compounding. This amount would be even more if the interest is compounded daily, adding up to 12,213 TRX.
APY offers a considerably higher interest payout in just a single year compared to APR. This compounding effect can make an even bigger difference in the long run. It’s the reason why Albert Einstein referred to compound interest as the 8th wonder of the world.
Conclusion
As someone in the crypto arena trying to yield or stake their digital assets for more income, it is important to know whether the advertised percentage of return/interest is APY or APR. The fact is that a lower APY can fetch better returns than a higher APR, especially in the long run. Also, it is essential to check whether the advertised APY is compounded monthly, weekly or daily. This can again make a vast difference in the total returns provided.
First Published: Aug 19, 2022 7:43 PM IST
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