What is APY in crypto and why is it vital for crypto investing?
By Yuliia Rokytska 2127 18 Aug 2022
An APY is an annual percentage yield that not only brings the investor a partial return on their investment but also a percentage of the pledged rate.
What is APY?
Cryptocurrencies attract the most daring investors with their high or potentially high prices and the opportunity to get a significant APY. Various DeFi services – cryptocurrency lending platforms, cryptocurrency exchanges, and market makers – help them do this.
APY (Annual Percentage Yield) is an annual investment income that considers compound interest accrued above the interest from the initial investment. That is, the investor receives a set interest rate and profit calculated from it.
The APY formula is as follows:
APY = (1 + r/n )n - 1,
where “r” is the annual interest rate,
and “n” is the number of compound interest periods per year.
You don’t have to calculate the rate yourself. There is an APY calculator for that: it can easily be found on the Internet.
The crypto market’s annual interest income is much higher than traditional banking and classic savings accounts. But don’t forget – the bigger the potential profit, the more significant the risks.
When is APY used in the crypto sector?
APY is used as a method of reward in many crypto investing areas.
Providing liquidity and yield farming
Many cryptocurrency exchanges, especially automated market makers, offer owners of digital assets to receive an annual percentage income for providing liquidity.
This requires making a deposit with crypto and locking the amount in the account to receive a reward in the form of a certain cryptocurrency. DeFi platforms distribute profits depending on the share of participants in the total liquidity pool.
It is also possible to earn on APY with yield farming. To join yield farming, you don’t need to withdraw tokens received from providing liquidity but rather lend them to the platform.
This is another way to generate passive income in the form of APY from available cryptocurrencies. It requires investors to lend funds at interest. Cryptocurrency lending platforms are intermediaries between those who lend and those who borrow.
APY is often used for staking. As a reminder, staking is the locking of tokens, which operate on the Proof-of-Stake consensus mechanism in the stake pool to keep the blockchain running, as well as to verify transactions and add new blocks to the network. The staking participants receive income for their service in the form of a percentage of the amount of the lock. Staking is very popular in the cryptocurrency community because it offers a high APY.
How does APY work?
APY in the cryptosphere functions differently from the traditional financial sector. An investor receives an interest rate based on the amount invested, not on the dollar value of assets. Let's say a person chooses 5% APY income and deposits 1 bitcoin, then after 12 months, s/he will receive 0.05 BTC in interest. The price of BTC will not influence the chosen interest rate. This is why some investors are so attracted to the cryptocurrency market.
From time to time, you may come across platforms that offer enormous rates, reaching 1000%. This indicates fraud. It would help if you never trusted companies that promise too high profits. More real and safe rates are from 5 to 17%, sometimes 30%.
In addition, the final annual percentage yield depends on many factors:
- the macroeconomic environment;
- level of supply and demand;
- the frequency of accrual periods of compound interest.
And only the latter can be influenced. The longer the APY accrual period, the more substantial the return.
What is a seven-day APY in crypto?
Traditional banking offers an interest accrual once a month. Whereas in the cryptocurrency industry, you can set shorter interest payment periods starting from 7 days. There are compelling reasons for the short accrual periods.
First, it is due to the volatility of cryptocurrencies. A seven-day APY can reduce the effect of price fluctuations. In addition, frequent payouts help to ensure that the promised annual percentage yield corresponds to reality. Thus, the investor has more confidence for long-term investments at interest. Even shorter accrual periods can be used to test the service.
APR vs. APY crypto
APR is the annual interest rate. The main difference between these two concepts is that APY accrues compound interest, while APR does not. Also, note that the annual interest rate includes additional costs from the transaction. That is, APR is accrued with the inclusion of fees by using simple interest. Therefore, the APY will always generate more profit. Especially over the long term and with monthly reinvestment.
So, the annual percentage yield brings cryptocurrency owners interest from interest and interest from the initial investment. Consequently, this tool is more profitable and popular than a simple rate in annual terms.