Understanding APY and APR in Investment

TL;DR

- In Cryptocurrency investment, APY and APR are used to estimate interest rates for credit and investment products.

- APY and APR significantly impact how much you will earn when saving/lending or have to pay when borrowing crypto assets.

- The difference between the two is that APY considers compound interest, whereas APR does not.

- The return investors receive with compound interest is more remarkable because interest is calculated on the principal plus previously earned interest. In addition to the interest that accrues on the principal, the reward will continue to grow due to the interest accrued over time.





Introduction

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The crypto & finance world is full of new blockchain-related terminologies and technical terms that can seem overwhelming. Some are also associated with banking industries and investments, which may be unfamiliar to many people. As a result, it's easy to see why many investors, particularly beginners, may need clarification on all of these particular definitions and terms. When investing, borrowing, or lending digital assets, you may come across two key terms: Annual Percentage Yield (APY) and Annual Percentage Rate (APR). Whereas the two terms may appear to be synonymous, they are not. Understanding them is crucial for investors to maximize investment returns and reduce interest when taking loans.


Understanding Annual Percentage Yield (APY)

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Annual Percentage Yield (APY) is the actual rate of return earned from a one-year investment that takes compound interest into account. It is a method for determining and calculating the number of money investors earn from financial market accounts over a year. With APY crypto, investors can deposit their cryptocurrency assets with investment firms and earn a rate of return over a specific period. The annual percentage yield, or APY, is what the borrower must pay as a percentage of the total amount received as a loan.

Generally, investment firms offer a variety of crypto profit-sharing programs or features to investors. Fees, interest rates, and the types of crypto assets available vary by program.
Compound interest refers to the amount received for the principal (money deposited into your account) and the interest earned on the investment. Compounding allows you to earn money over time, making it an excellent investment strategy.

In the cryptocurrency industry, compound interest is used in crypto savings, where investors deposit their money and get a return on it over time. It enables investors to obtain a higher fixed interest rate. Furthermore, there are numerous crypto yield programs from which you can choose. Just make sure you do your homework before subscribing to one.


What is Annual Percentage Rate (APR)?

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The Annual Percentage Rate, or APR, is essentially the annual rate of return or the interest the borrower must pay investors, expressed as a percentage. APR calculates additional transaction costs and, unlike APY, does not account for the compounding interest of the investment over the year. APR is also a simple interest rate because the initial investment determines the profit.

The annual interest rate provided to customers who loan their tokens or crypto assets for borrowers to obtain at investment firms or cryptocurrency exchanges is referred to as the crypto APR.

Crypto assets held by investors will be locked in a set period, and they will receive a higher fixed rate of interest.

In crypto, you have two options: lend your cryptocurrency and earn an annual percentage rate, or borrow some cryptocurrency assets and pay the lender's fees. Because different platforms offer different rates, it is highly recommended that you stake your assets across multiple platforms to maximize your returns.

Types of loans

In general, cryptocurrency exchanges provide two types of loans:

1.Fixed lending requires investors to secure their money for a period (usually seven to nine days) to receive a fixed interest rate. The benefit is that this method usually provides a higher rate of interest.

2.Flexible lending works much like a savings account. Because you can withdraw your assets at any time, the rate of return is usually lower.


What are the differences between APY and APR?

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The terms APY and APR for cryptocurrency are nearly identical in that they are both standard interest rates expressed in terms of annual percentage. Nevertheless, there are several distinctions between the two.

The first distinction is in the function. APY generally refers to the total amount of interest earned, whereas APR refers to the amount of interest that must be paid. According to a fixed interest rate for a year, annual percentage yield (APY) measures the total amount of interest earned on a particular investment. Meanwhile, APR is a percentage rate representing the annual credit cost. The differences are highlighted below.

1.APY considers compound interest, while APR does not consider compound interest.

2.The compounding effects result in higher investment growth/borrowing costs in APY, while investment growth and borrowing cost are lower in APR.

3.Whereas APY is recommended for savers/investors, APR is recommended for borrowers.


How to calculate APY and APR

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

APR= ((fees+interestprincipaln)*365)*100

Where Interest = Total interest paid over life span
Principal = Loan amount
n = loan duration.

For example, an investment product offers a monthly interest rate of 2%. If the reward offered is an APR, the return will be 24% (2% x 12 months = 24%).

And all the while, if the investment product pays APY interest at a compound interest rate of 1% per month, the annual interest rate is 12.68%

[(1 + 0.01/12)12-1 = 12.68%].
If you keep the same balance for a year, the interest rate will be 12.68% due to compounding each month.


Conclusion

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The compounding effect in APY is considered more profitable because it can provide a higher yield. It means you will earn interest on interest and will be able to add the extra profit to your initial investment.

Meanwhile, as a borrower, you should pay off the balance over time, so look for the lowest possible interest rate. To reduce the amount of interest, avoid compound interest and instead use APR. This concept applies in various situations, including personal loans, credit card debt, and crypto loans.

In the final analysis, select the best rate for your benefit, one that is legitimate and serves your best interests. Also, when you invest through any platform, always pay attention to the type of interest that the platform provides, as some may present the yields in APR, whereas others may use APY.




Author: M. Olatunji, Gate.io Researcher
* This article represents only the views of the observers and does not constitute any investment suggestions.
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