What Is APY in Crypto?

Beginners often ask the question, what is APY in crypto? Put simply, the APY—or annual percentage yield—is the rate of return offered by earning products, such as savings accounts and staking, over a year.

So, if you invest $1,000 worth of Bitcoin at a 10% yield, you’d receive $100 after 12 months. The earnings will be slightly higher when factoring in the compound effect.

This guide explains everything you need to know about APY in crypto. Read on for more information about how APYs are calculated and what crypto markets they’re related to.

How Does Crypto APY Work?

We’ve covered the basics, so let’s take a closer look at how crypto APYs work.

First, you’ll often come across the term ‘principal’ when investing in earning products. This simply means the original investment amount. This is specified in the crypto asset rather than monetary terms.

• For example, suppose you invest 1 ETH into a savings account.
• The principal will always be 1 ETH regardless of Ethereum’s market price.

Like traditional investment agreements, the principal is returned after the lending term has passed. This could be a flexible or fixed term. For instance, flexible agreements allow you to withdraw the principal, plus any earned interest, at any time.

Conversely, fixed terms aren’t as flexible. You must wait for the term to pass before having the principal returned. That said, fixed terms often come with higher crypto APYs, as the funds are locked for a set period.

In addition, crypto interest rates come in two common mechanisms; simple and compound.

Simple Interest

Simple interest is the easiest formula to understand.  It means the interest earned is based solely on the principal amount.

For example:

• Let’s say you invest 10 SOL(the principal) into a savings account.
• The savings account pays an interest rate of 8%.
• This means after 12 months, you’d earn 0.8 SOL in interest (8% of 10 SOL).
• Once withdrawn, you’d receive 10.8 SOL (10 SOL + 0.8 SOL).

As always, the earnings are reduced when holding for under 12 months. For instance, if you invested that 10 SOL for three months, the earned interest would be 0.2 SOL (0.8 SOL / 12 * 3).

Compound Interest

Compound interest is more lucrative for investors. The earnings are not only based on the principal but also the interest that accumulates during the term. Put otherwise, you earn ‘interest on the interest’.

Calculating compound interest is a little more complicated than simple interest. For example:

• Let’s say you lend 1 BTC to a crypto lending platform.
• The account compound interest rate offered is 5%.
• In month 1, you earn interest on the 1 BTC principal, which is 0.004167 BTC (1 BTC * 5% / 12 months).
• In month 2, the interest is earned on the 1 BTC principal, plus the 0.004167 BTC interest from the previous month. This totals 1.004167 BTC, meaning the interest earned in month 2 is 0.004184 BTC.

The above process repeats every month until the lending agreement is over. The specific time frame will depend on whether you’ve opted for a flexible or fixed term.

Crypto APY Formula

The crypto APY formula uses the compound interest mechanism. This ensures the earnings compound over time, allowing investors to maximize their returns.

Here’s the formula used:

APY = (1+r/n)n – 1

So, the ‘r‘ represents the annual interest rate, but calculated as a decimal. For example, if the interest rate is 7%, 0.07 is entered in the formula.

The ‘n‘ is the number of compounding periods. For example, some crypto products compound the interest weekly. This means that ‘n‘ = 52. However, others compound the interest monthly. This means ‘n‘ should be 12.

Difference Between APY and APR

We’ve established that the APY means the annual percentage yield. But what about the APR? This stands for the annual percentage rate.

• The APY considers the account compounding interest.
• While the APR uses the simple interest mechanism.
• However, the APR also includes fees associated with the lending agreement.

This is why, in general, the APY applies to lenders. For instance, lending cryptocurrencies to a staking or liquidity pool.

Conversely, the APR applies to borrowers, such as those taking out a crypto loan. Sustainable lending practices dictate that the APY must be higher than the APR. This covers the interest paid to lenders, plus operating costs, default coverage, and other potential fees.

For example:

• Suppose you lend 2 ETH to a crypto loan site. The site offers an APY of 6%
• A borrower takes out a 2 ETH loan and pays an APR of 8%.
• The borrower covers the 6% APY earned by the investor
• The 2% is kept by the crypto loan site.

Different Compounding Periods of APY

The APY determines the interest yield over 12 months. Hence, the ‘annual’ percentage yield. However, you might also come across platforms that state shorter-term yields, such as daily or weekly.

While these aren’t the same as the APY, the fundamentals remain constant.

For example:

• Suppose you’re using an automated crypto trading platform that also offers staking pools.
• The staking pool offers a 7-day interest yield of 1%.
• That 1% can be converted into an approximate APY.
• We’d simply need to multiply the yield (1%) by the number of periods (7 days) in a year.
• That’s an approximate APY of 52% (52 x 7 weeks = 1 year)
• We stress ‘approximate’, because this doesn’t include the compound returns.
• Therefore, the actual APY would be slightly higher, depending on how often the interest is compounded.

Nonetheless, shorter-term interest rates are based on the yield, rather than an APY. This means you simply need to calculate the percentage by the investment amount.

For example, suppose you invest 1 BTC at a 7-day yield of 1%. This means after 7 days, you’d earn 0.01 BTC in interest. You’d also receive the principal back (1 BTC), meaning your total returns are 1.01 BTC.

Conclusion

In summary, the APY in crypto highlights how much interest you’ll earn over 12 months. This covers various products, including staking, savings accounts, lending pools, yield farming, and liquidity farming.

Just remember—the APY is often variable, meaning it can change at any time. This can be a positive or negative change, depending on broader market conditions.

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