APR vs APY in crypto: What's the difference? Which one to choose for profit?

In the world of investing and lending, you often encounter the terms APR and APY. Both seem similar, but the difference between APR and APY is very important when making investment decisions, especially in the digital currency and DeFi space. These interest rates directly affect the amount of money you receive or pay out.

What is the difference between APR and APY?

Before diving into details, let’s understand the basic difference. APR stands for Annual Percentage Rate, which means “interest rate per year” in a simple form. Meanwhile, APY stands for Annual Percentage Yield, which means “annual return” and takes into account compound interest.

This small difference can significantly impact your returns. When you use APR, you calculate interest only on the principal. When you use APY, you earn interest on both the principal and the accumulated interest, meaning your returns grow over time.

Understanding APR: The basic interest rate you need to know

APR is a fundamental concept used to calculate the cost of borrowing money. It tells you that if you borrow 100 units at an APR of 5%, you will owe 5 units in interest after a year.

In credit card lending environments, APR is often not charged immediately if you pay the full amount by the due date. However, if there is a balance remaining, interest at the APR rate will be charged each billing cycle.

There are two types of APR: fixed (Fixed APR), which does not change during the loan period, and variable (Variable APR), which can fluctuate with market conditions. Borrowers may pay more interest when market conditions are volatile.

It’s important to remember that APR generally does not include fees and taxes, so it may not reflect the total true cost. Always read the terms and conditions carefully, as there may be other penalties not included in the APR.

APY: The compound interest mechanism that offers better returns

APY differs from APR in that it accounts for compounding interest. When interest is compounded, you earn interest not only on the principal but also on the interest earned previously.

Imagine stacking hay bales—each new bale is added on top of the previous one, causing the stack to grow faster over time. Similarly, compound interest causes your investment to grow at an accelerating rate.

For example, if you invest 1 ETH in a DeFi platform offering an APY of 24% with daily compounding, you will earn interest every 24 hours, not just at the end of the year. This means your total return will be more than the initial 24%. Although the difference may seem small, over the long term, it can make a significant impact.

Applying APR and APY in the crypto world

In the crypto industry, APR and APY play crucial roles in passive investments, allowing your money to work for you.

Staking is one of the most popular methods. You lock your tokens on a blockchain and earn interest based on the APR or APY. The interest rate depends on the protocol’s consensus mechanism. Some platforms offer straightforward staking with APR, while others offer daily compounding with APY.

Yield farming is another strategy. You provide your tokens to a liquidity pool via a DeFi platform and earn interest or trading fees generated from the pool. The returns are often expressed as APY because they are frequently compounded.

One of the advantages of crypto interest is that there are usually few hidden fees. Interest is calculated from your invested principal. For example, if you invest 10 BTC at 6% APR, after one year, you’ll have 10.6 BTC.

How to calculate APR and APY for investment decisions

Calculating APR is straightforward: multiply the periodic interest rate by the number of periods in a year. For example, if the monthly interest rate is 0.5%, the APR is 0.5% × 12 = 6%.

APY is a bit more complex because it considers compounding. The formula is (1 + r/n)^n - 1, where r is the periodic interest rate, and n is the number of compounding periods per year.

For daily compounding at 6% APR, the APY is approximately 6.18%. The difference may seem small, but over large investments or long periods, this additional return accumulates.

How to choose between APR and APY for your crypto investments

The key question is: which one is right for you? The answer depends on your role as an investor or borrower.

If you’re an investor or lender, APY generally offers better returns because you earn interest on interest, leading to faster growth of your investment. Therefore, APY is a good choice for long-term wealth building.

If you’re a borrower, APR is preferable because a lower APR means less interest paid. When evaluating borrowing options, look for the lowest APR possible.

In the crypto context, if you find high APY rates, it could be an opportunity for passive income, but caution is advised. Very high APYs may come from new protocols with higher risks. Always check the transparency and credibility of the platform.

Real-world example: If you have 10,000 baht to invest at 5% APR, you’ll earn 500 baht in interest in the first year. At 5% APY with daily compounding, you’ll earn slightly more—over 512 baht in 3 years, the difference grows to about 1,576 baht compared to 1,500 baht with just APR.

Summary

Understanding APR and APY is essential for successful crypto investing. The difference may seem small, but its long-term impact on your returns can be significant. When choosing platforms for DeFi or staking, ensure the rate offered is APY, not just APR, because compounding interest can significantly boost your earnings without additional effort.