Investing
Bybit Learn
Bybit Learn
Intermediate
Aug 23, 2022

APR vs. APY in Crypto: What's the Difference?

APR (annual percentage rate) and APY (annual percentage yield) are key concepts used in the calculation of interest from a variety of crypto investments or loans. The investments may include the provision of funds to liquidity pools on exchanges, staking, yield farming, crypto savings accounts and more.

Some of these investments may pay you interest based on the APR rate, while others use the APY method of calculating the payout. For any crypto investor, it’s imperative to know the difference between APR and APY to allocate your funds to the most profitable income sources.

What Is APR?

Many people are familiar with the interest rate paid on savings accounts or charged for loans by traditional financial institutions. When you’re quoted a 5 percent annual interest rate, your investment of $100, for example, will generate $5 in profit exactly one year from the time you invest. Alternatively, if you borrow $100 at the same interest rate, you’ll have to pay back your borrowed amount plus $5 in interest after one year.

This simple interest rate calculation is based on APR. APR, or annual percentage rate, whether in traditional banking or the crypto world, refers to the ordinary interest applied to the principal amount of an investment or loan. It doesn’t take into account the concept of compounding interest, which we’ll discuss in this article.

APR is an annualized figure. If an investment or loan is held for less than a year, the interest applies on a pro-rata basis. For example, a half-year investment with an APR of 5 percent will earn you exactly half the interest, 2.5 percent, on your principal amount.

Let’s say you invest 1.0 Ether in a lending pool on a decentralized finance (DeFi) platform to earn some interest, and the interest rate in APR is 24 percent. If you lock your funds in the pool for exactly 365 days, your total investment will grow to 1.24 Ether. This includes your principal of 1.0 Ether and the 0.24 Ether (based on the 24 percent APR) that accrued as interest.

APR is a pretty straightforward interest rate concept. Below is the basic formula for calculating a total final amount based on APR:

A = [P × (1 + R×T)]

where

A — total final amount

P — principal, i.e., the initial investment or loan amount

R — interest rate used

T — time in years

Using our 1.0 Ether investment, the figures in the formula are:

1.0 Ether (1 + 0.24×1) = 1.24 Ether

This assumes an investment period of exactly one year. If you hold the investment for a three-month period, i.e., one quarter (0.25) of a year, then the formula yields:

1.0 Ether [1 + (0.24 × 0.25)] = 1.06 Ether

What Is APY?

APY, or annual percentage yield, is a measure of interest applicable to an investment or loan that takes into account compounding or compound interest. The interest can be compounded at any set period — either continuously, daily, weekly, monthly or annually. The inclusion of compounding interest makes calculating APY more complex, as it takes into account the number of periods at which the amount is adjusted based on the interest rate.

The formula for the final amount based on APY is as follows:

A = [P (1 + R/N)N]

where

A — total final amount

P — principal, i.e., the initial investment or loan amount

R — interest rate used

N — number of compounding periods

The important part of the formula is the N value — the number of compounding periods. It’s what makes APY and APR different. The number of compounding periods is the number of times the investment amount is recalculated based on the quoted nominal interest rate.

During each recalculation, the interest is added to an amount that includes the initial investment plus all the previously accrued interest earnings.

Let’s imagine you invest 1.0 Ether for one year at the APY rate of 24 percent, and your investment has two recalculation periods: At 6 months and 12 months. In this scenario, the figures in the APY formula are:

[1.0 Ether × (1 + 0.24/2)2] = 1.2544 Ether

How Compound Interest Works

Compound interest, due to the periodic recalculations, increases the total final amount compared to using the simple APR-based interest.

Hence, the same initial investment (1.0 Ether) over the same period (1 year) with the same quoted interest rate (24 percent) produces the final payouts of 1.24 Ether using APR and 1.2544 Ether using APY. As you see, with compounding interest, your APY interest is magnified over time as compared to APR interest.

The more compounding periods used during the investment period, the higher your final amount. For instance, if your 1.0 Ether yearly investment at an APY of 24 percent is compounded on a monthly basis, i.e., 12 times during the period of investment, then the final payout will be as follows:

[1.0 Ether × (1 + 0.24/12)12] = 1.2682 Ether

The Difference Between APR and APY

Compounding is the only difference when you calculate APR and APY returns. With all other things being equal (the initial investment, the quoted interest rate, the period of investment), APY will always result in a higher final amount.

In practical terms, it means that if you borrow money, it’s better to do it using APR rates. On the other hand, if you invest funds, APY rates will give you higher total returns.

Where Are the APR and APY Used In Crypto?

In traditional finance, APR rates are widely advertised, particularly for loan products, while APY rates are more often used to market some investment products. In the world of crypto, both APR and APY are used extensively on DeFi protocols, centralized exchanges (CEXs) and other finance-related crypto platforms, for a variety of lending and borrowing opportunities, liquidity pools, staking services, yield farms and more. Most large DeFi and centralized crypto finance providers have products with both APR and APY rates.

Staking pools with investment opportunities in APY and APR advertised on the world’s most popular DeFi platform ― PancakeSwap

Source: PancakeSwap.finance

When borrowing funds or investing on platforms using APY rates, pay close attention to the mechanism of compounding; i.e., how many times and at what intervals your investment or loan will be compounded.

APR vs APY In Crypto: Which Is Better?

Naturally, APR rates are better for borrowing money, while APY is more beneficial for investing. The effect of compounding can work wonders for you when investing crypto for yield.

For example, the Bybit Savings product suite allows you to stake a variety of popular coins with interest paid in APY in a low-risk, guaranteed-withdrawal environment. You can choose between flexible and fixed-term investment periods. The platform currently offers an APY rate of 5 percent and above for some stablecoins. These are some of the highest APY rates in the industry for stablecoin investments.

Some of the current offers on Bybit Savings

Source: Bybit.com

Other Crypto Investment Factors Besides APR and APY

When researching crypto investment opportunities on DeFi and centralized platforms, comparing APR and APY (and looking at the advertised interest rates) is only one factor in making a decision. Additional factors to take into account include:

Fees and costs

Various fees usually accompany crypto investment opportunities, including those for transactions, withdrawals, closing costs and gas, which are charged by the underlying blockchain on decentralized platforms. Always take these fees into account when calculating your overall final returns. An opportunity with a high APR or APY, but an unfavorable fee structure, may work out much worse than you initially expected.

Variable vs. fixed APR and APY rates

Make sure you understand whether the advertised APR or APY rates are variable or fixed. Fixed rate opportunities apply the advertised interest rate for the duration of the investment, while variable rates are subject to fluctuations depending on market conditions.

Additional benefits and rewards from the investment

In some cases, in addition to earning interest on your investment, you may get side benefits such as liquidity provider (LP) tokens. These tokens may be reinvested on the same or other platforms for further yields.

The invested coin’s current performance and future outlook

Some DeFi farms and pools advertise eye-popping APR and APY rates. However, these opportunities are often based on highly volatile coins with an unstable future outlook. These coins might also have very high inflation rates. The inflation rates and volatility might lead to the coin’s future depreciation in value.

While your investment is earning a high return based on attractive APR or APY rates, the coin you’ve chosen may be depreciating on a wider scale in the market. For instance, an APY or APR of 300 percent will be of little value if the cryptocurrency you’ve used drops in price by 400 percent during the year of your investment.

The platform’s reputation and size

Larger and more established platforms, such as PancakeSwap and Uniswap, have been tested by time and usually have ample liquidity. It’s best to stick with these providers, even if you have spotted those great APR and APY rates on a smaller platform. In an industry awash with scams, rug pulls and project failures, this point is of great importance to any crypto investor.

The Takeaway

The crypto industry offers a vast array of investment and borrowing opportunities based on APR and APY rates. Due to the nature of the crypto market, the APR and APY rates are often a few magnitudes higher than those you may have encountered in the traditional finance industry. This opens up more lucrative return opportunities, but also carries more risks.

When investing or borrowing based on these rates, ensure that you understand whether you’ll earn or pay based on APR or APY. If the latter is applicable, pay close attention to the compounding periodicity that will apply to your investment or loan.