If you are taking part in yield farming, you might have already heard of APY or APR. They are used in many yield farming programs in DeFi protocols. In order to truly understand this market, you need to dig into basic terms such as APY coin.
In this article, we’ll make the explanation of APY simple and show you how to calculate it in your yield farming. Be patient and read this post to the end as it is not only important, but also gives information that helps you to invest more effectively.
What Is Annual Percentage Yield (APY)?
If you want to understand APY, it is necessary to learn the difference between simple interest and compound interest first.
Simple Interest Vs. Compound Interest
Simple interest is the interest earned only on the original deposit while compounding is the process of adding interest earned every period on both the original investment and the reinvested earnings (herein the interest earned from the previous period).
To better illustrate these concepts, we’ll provide an example:
You have 100 dollars and you lend it to someone at an interest rate of 10 percent annually in January 2020. In January 2021, you hope to get your money back and receive an amount of interest, which is 10 dollars.
The sum of money you would receive after a year equals:
100 * (1+10%) = $ 110
Now let’s take a look at another scenario. In this case, you also have 100 dollars and you lend it to your friends at an interest rate of 10% annually and the loan compounded semi-annually
In the first 6 months, you would have:
100*(1+5%) = $105
The sum of money you would receive after a year equals
105*(1+5%) = $110.25
So at the end in january 2021 when you get your money back you get 110.25. This 25 cent is the magic of compound interest.
Compounding allows you to produce money over time, which is why it is such a powerful investing tool. This is not the same as simple interest. The term “simple interest” refers to interest earned just on the principal deposit.
Annual Percentage Yield
APY – Annual Percentage Yield is the effective annual return, taking into account the effect of compound interest. Unlike simple interest, compound interest is calculated periodically and the amount is immediately added to the balance. With each subsequent period, the account balance gets slightly larger, so the interest paid on the balance is also larger.
The annual percentage yield (APY) is a way of measuring how much money a money market account earns over the course of a year. To put it another way, this is a method for measuring the accumulation of interest over time.
If you are a crypto investor looking to get a return on your investment while holding it, cryptocurrency savings accounts with APY may be precisely what you need. There are a variety of cryptocurrency yield schemes to select from. As a result, before joining up for one, do your research. Fees, entry restrictions, interest-earning procedures, and the types of crypto assets accessible may differ from platform to platform.
There are also promotional APYs offered by crypto exchanges, but you should be cautious before investing in them. Some of these programs employ the tactic of first giving higher APYs to attract clients and then lowering the rates after a large pool of customers has been captured. If you come across a yield farming platform or program that offers high APYs, make sure to examine its community trustworthiness.
How To Calculate APY?
For you to understand better, I will explain more clearly the calculation of APY as follows:
APY = (1 + r/n)^n – 1
In which:
– r is the periodic rate of return (referred to as the annual APR).
– n is the number of years of compounding
For example, I will calculate with r rate of 55.44%, then I will have a calculation: APY = (1+ 55.44%/365)^365 – 1= 74.02%.
Difference Between APR And APY
When it comes to APR in the context of savings, it means a recurring rate. For example, if you save $1,000 in your account with an APR of 10% and that interest is calculated once a year, you will receive $100 interest after 1 year.
And APY will be based on the effect of compound interest. If you still use the example above, you have $1,000 with an APY of 10% and that interest is paid twice a year. For the first 6 months you get 50 USD (1000 * 10% / 2).
However, in the last 6 months of the year, you will add 50 USD in the money received in the first 6 months. At this point, the amount you receive will be 52 USD (1050 * 10% / 2).
APR is usually charged on credit card loans, this is the interest rate charged on the outstanding balance of the credit card that the person has not paid. Meanwhile, APY will apply to the case of businesses coming to deposit money at banks. Banks often use APY to attract customers to deposit money.
Usually banks will keep secret the difference between APR and APY. However, if you take a look at the above example, you can see that the higher the annual interest rate, the bigger the difference between APR and APY.
The difference between APR and APY can have a significant impact on the financial decisions of borrowers and investors. In summary, banks often emphasize APY to attract investors in savings accounts and show how high interest rates are. While you are applying for a credit card or loan, they will insist on the APR to show you the actual cost to be paid.
Conclusion
It’s easy to understand why many yield farmers feel confused about APY. Understanding this fundamental in DeFi will help you manage your investment better since it has a major impact on how much you earn or pay.
We also tell the difference between APY and APR with the hope that you won’t get these two similar concepts mixed up. While APR and APY may seem similar, they are not the same thing. For starters, APY, or annual percentage yield, considers compound interest, but APR, or annual percentage rate, does not.
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