What is APY? Understanding it for smart investing in the digital world

APY is the annual percentage yield that considers the effects of compounding interest. The difference between APY and APR is important because it impacts your investment decisions. If you’re still confused about these two concepts, this article will help you understand the differences and how to apply them fully in crypto investing.

What is APY? The interest rate that accounts for compounding

APY stands for Annual Percentage Yield, which refers to the percentage return per year. When your investment involves compounding interest, APY takes into account the effects of interest accumulation. This means you earn not only on your principal but also on the interest that has been compounded.

For example, if you invest 1,000 THB at an APY of 5% per year with monthly compounding, in the first month you earn 4.17 THB. Then, in the second month, interest is calculated on 1,004.17 THB, not just 1,000 THB. This process repeats throughout the year, resulting in a higher return than initially projected.

APR is the interest rate that does not consider compounding

APR stands for Annual Percentage Rate, which is a simple interest rate that does not account for compounding. If the APR is 5% per year, it means a 1,000 THB investment will earn 50 THB interest once in that year. If broken down monthly, you get 4.17 THB per month (50 ÷ 12), and these interest payments are not compounded in subsequent months.

Key differences between APY and APR in crypto

Understanding these differences is crucial for your investment decisions:

Impact of compounding interest

APY considers interest compounding, so for the same interest rate, the return calculated with APY will always be higher than with APR. For example, at a base rate of 6% per year:

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

As shown, the more frequently interest is compounded, the higher the actual return.

Investment advice

If you’re an investor or lender, APY is the better choice because it reflects higher returns due to compounding. Conversely, if you’re a borrower, APR provides a clearer picture of your costs, as it shows the lower interest rate you pay without considering compounding.

Usage in DeFi platforms

In digital currencies, APY represents the real return from investments on DeFi platforms. Many platforms offer staking and yield farming with APY because daily compounding is common. This means the system calculates and adds the interest to your account every 24 hours.

How to calculate APY and practical application

The formula for APY is:

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

where:

• r = annual interest rate in decimal
• n = number of compounding periods per year

Example: If you invest 10 Bitcoin (BTC) at 6% annual interest with daily compounding (n=365):

APY = (1 + 0.06/365)^365 - 1 ≈ 0.0618 or 6.18%

This means after one year, your 10 BTC will grow to approximately 10.618 BTC (before fees and taxes).

Case study: APY in staking and yield farming

Staking with APY

Staking involves locking your digital coins in a blockchain to earn interest. If your staking platform offers an APY of 12% with daily compounding, investing 1 ETH will yield about 0.12 ETH annually. Since interest is compounded daily, your investment grows faster than with the same APR.

Yield farming on DeFi platforms

Yield farming involves providing your digital assets to liquidity pools on DeFi platforms to earn transaction fees and bonuses. Understanding APY here helps you evaluate the actual returns after considering compounding effects.

Investment decision: APY or APR?

When evaluating investment opportunities, ask yourself:

If you’re an investor: Look for APY, as it shows the true return, including compounding effects.

If you’re a borrower: APR helps you understand the lower cost of borrowing (excluding compounding). However, in crypto loans, compounding is often considered in the actual APY.

Real-world comparison example

Consider investing 10,000 THB:

With APR 5% (no compounding):

• Year 1: 500 THB → total 10,500 THB
• Year 3: 1,500 THB → total 11,500 THB

With APY 5% (annual compounding):

• Year 1: 500 THB → total 10,500 THB
• Year 3: approximately 1,576.25 THB → total 11,576.25 THB

The difference of about 76.25 THB may seem small, but at higher rates common in crypto markets, a 3-5% difference can be significant.

Summary: APY as a key tool for investment planning

APY reflects the total return including compounding, unlike APR which is a simple interest rate. For crypto investors, understanding this helps make smarter investment choices, especially when selecting DeFi platforms for staking or yield farming. High advertised returns should be checked whether they are APY or APR, as APY will always show a higher figure under the same conditions.

Using online calculators can simplify these calculations, allowing you to focus on choosing the best investment platform for your needs.