APY and APR are two of the concepts that we most often see in the crypto world, especially in DeFi and in tools for staking and Bit2Me Earn. The APR comes from the English Annual Percentage Rate, or equivalent annual rate (TAE, as it is known in Spanish), while the APY comes from the English Annual Percentage Yield). Both concepts refer to the annual interest generated by a sum of money that is charged to borrowers or paid to investors, although as you will see, each concept does so in a slightly different way.
Se is usually expressed as a percentage that represents the actual annual cost of funds over the term of a loan or income earned on an investment. This concept includes all commissions or additional costs associated with the transaction, but does not take capitalization into account. Thus, the APR often provides bottom-line information that they can use to compare between lenders, credit cards, or investment products.
How does the APR work?
As we have already said, the APR is an annual percentage rate that is expressed as an interest rate. It is used for calculate the percentage of the principal that will be paid each year taking into account aspects such as monthly payments. The APR is also the annual interest rate paid on investments without taking into account the compounding of interest within that year.
How is the APR calculated?
The APR is calculated by multiplying the periodic interest rate by the number of periods of the year in which it has been applied. It does not indicate how many times the rate is actually applied to the balance.
APR = ((((Fees+Interest) / Principal) / n) × 365 ) × 100
where:
Interest = Total interest paid over the life of the loan
Main= Loan amount
n= Number of days of loan term
Financial instruments may have different ways to calculate this interest rate. For example, in a credit card, these values vary depending on the type of charge, the credit history of the person and in some cases by the level or type of credit card. In addition to this, other factors such as cash advances, payment delays or other functions of said cards can also be taken into account, which can affect the APR.
For its part, bank loans usually have a fixed or variable APR. A fixed APR loan has an interest rate that is guaranteed not to change over the life of the loan or credit. A loan with a variable APR, for its part, has an interest rate that can change at any time, depending on market conditions, regulations or any element that the bank considers appropriate to take into account.
In any case, the APR does not take into account the compounding of interest in a given year: it is based solely on the simple interest that is applied to the funds.
What is APY?
The APY or Annual Percentage Yield, for its part, refers to the real yield interest that will be earned in a year if the interest is compounded. Compound interest is added periodically to the total invested, increasing the balance, so that the next interest calculation will take into account the new balance, applying the given interest. That means each interest payment will be higher, based on the higher balance. The more often the interest is compounded, the better the return.
How is APY calculated?
Calculating the APY is quite simple and we can do it using the following formula:
APY = ((1 + r/n) ^ n) – 1
Where:
r= is the annual interest
n= the number of compound periods per year
So for example we have to:
If we invest €5000, with an annual interest of 12%, compounded monthly, we will obtain an APY of 12,68%
APY = ((1 + 12%/12) ^ 12) – 1
APY = 12,68%
Which means that our €5000 will become €5000 * 12,68% = €5634,13. That would be the compound annual interest we will get for an APY of 12,68%.
What is the difference between APR and APY?
Although the APR only takes into account simple interest, the Annual Percentage Yield (APY) takes into account compound interest. Therefore, the APY of a loan is greater than its APR. The higher the interest rate - and to a lesser extent, the shorter the compounding periods - the greater the difference between the APR and the APY.
Imagine the APR on a loan is 12% and the loan is compounded once a month. If an individual borrows €5.000, her interest for a month is 1% of the balance, that is, €50. That makes the balance increase to €5.050. The following month, 1% interest is applied on that amount, and the interest payment is €50,5, slightly higher than the previous month.
If you carry that balance through the year, your effective interest rate becomes 12,68%. Instead, the APY includes these small changes in interest expense due to compounding, while the APR does not, which is the main difference between the two concepts.
What do APR and APY mean in the crypto world?
In the crypto world, APR is a widely used element in the DeFi world or in centralized investment instruments and loans with cryptocurrencies. While most large DeFi and crypto finance providers use APY, you can also use APR on many of them, especially when borrowing, leaving APY when investing in a platform and expecting rewards. . Although this depends on the decision of the DeFi application development teams, since this aspect can vary.
Eg Bit2Me Earn, staking is rewarded based on APY, which maximizes the potential earnings you can earn for each cryptocurrency you can stake on this platform.
But in AAVE, for example, you earn in APR, which reduces the chances of earning that can be obtained on this platform by placing our cryptocurrencies on it.
As you can see, each platform has its own formula, it is up to you to investigate which one can offer you the best rewards (DYOR), without putting your funds at risk.