What are the differences between crypto APR and APY? Annual Percentage Rate or APR and Annual Percentage Yield or APY are two different terms that may sound the same but these are certainly not created equal.
However, people get confused with these two terms due to this similarity.
Whether it is in crypto or in traditional fiat currency space, APR and APY are used in both and play a significant role in determining the returns an investor may expect from their investments or how much a borrower needs to pay on their credit products.
These two processes are not only used to calculate the interests on investments but also on all other credit products.
Both APR and APY are applied to the account balances but in different ways. You will need to know about these differences in order to have a better understanding of these two terms.
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7 Differences Between Crypto APR and APY
Here are some basic and more-than-basic differences between APR and APY that you should know before making any investment in crypto.
1. Interest Rates
One of the most significant differences between APR and APY is that the former is calculated on the basis of a simple rate of interest but, in contrast, APY is calculated on the basis of a compound interest rate.
2. Used for
APR or Annual Percentage Rate is actually the rate charged for borrowing or earning money but APY is usually charged for earning money on investments.
3. Primarily Used by
The investment companies typically allow the investors to earn their income on investments on the APY. On the other hand, the lenders usually advertise their loans and other credit offers such as mortgages and credit cards on APR.
4. Formula for Calculation
The formula used to calculate APR is – Periodic Rate x Number of Periods in a Year. However, while calculating the APR, the number of times the rate is applicable to the account balance is not indicated.
On the other hand, the formula used to calculate the APY is – (1 + Periodic Rate) x Number of periods – 1. However, unlike APR, when APY is calculated, the number of times the interest is applicable is not taken into account. It is due to the outcome of the intra-year compounding.
5. Reasons in Usage Differences
The financial institutions typically offer their loans using APR because it makes it look deceptive in the sense that the borrowers feel that they are borrowing the money at a low cost in the long run.
On the other hand, it is the subtle difference in the APR and APY formula that attracts the investors.
They feel that they can earn more on different investment options such as Certificates of Deposit or CDs, savings accounts, Individual Retirement Accounts or IRAs, and even crypto assets.
6. The Borrowers’ Viewpoint
The APR and APY both have different implications for the lenders and borrowers. The borrowers who look for the lowest possible rates on a loan product can find one easily.
However, a little bit of research is always recommended to find out whether or not there are any hidden clauses, fees and charges because banks usually quote the periodic rate of interest without bi-annually, quarterly, or monthly compounding which may be a bit confusing for the first timers.
On the other hand, in terms of APY the borrowers can get the benefit of monthly compounding. This means that the borrowers will pay interest every year at a significantly lower rate of interest.
However, this insignificant amount may prove to be quite significant especially when loans are amortized for a period of over 25 pr 30 years.
7. The Lenders’ Viewpoint
Both APR and APY can also affect the lending tree significantly. Since the lenders look to have the highest rate of interest the banks quote the APY which looks quite attractive as opposed to the APR.
Due to compounding of the interest your savings account can accrue a significant amount of money pretty quickly which is what all lenders want.
On the other hand, if lenders receive their interest on the basis of APR, their return on investment will be significantly less.
Which is Higher Yielding – Crypto APR or APY?
Typically, APY will produce higher returns on your investments as compared to APR for the same period of time.
In the DeFi and crypto world, for example, you can earn handsome returns while staking your crypto coins and adding them to the coins that you have staked overall.
This means that you will make more profit when you make subsequent investments. This is due to their differences in calculating methods and others as mentioned above.
However, there are also other things to know in order to determine which among APR and APY produces a higher yield.
In terms of the amount of APR and APY, the difference is inversely proportional to the frequency at which this interest is compounded.
This means that if the interest compounds more frequently, the difference between APY and APR will be greater.
APR or Annual Percentage Rate does not only refer to the annual funds that you may receive on your investment as interest but it typically includes fees and other additional costs, if any, that you need to pay during the tenure.
Also, APR does not integrate compounding interest but rather sticks to its very essence of providing returns based typically on the simple interest rate.
Therefore, whatever you will earn will be directly proportional to the original investment amount.
However, when you consider the APY, your income may change radically primarily because it considers compound interest, which, in simple terms, is a process in which you get interest on interests.
This usually gets added to the profit by inflating the initial amount of money investment.
Therefore, considering all the above facts and information mentioned above, it can be said that in spite of being almost the same tool used for the similar purpose of calculating annual investment interest, there are significant differences between them.
All the differences can be summarized as follows:
- APY and APR produces different results
- APY produces a higher yield profit than APR
- APY incorporates compounding while APR uses a simple rate of interest and
- Most cryptocurrencies and DeFi tools use APR as of now and not APY.
All these means that you will not be able to receive as high returns as offered on other traditional financial assets by investing in cryptocurrencies which typically use APR.
However, if you want to earn compound interest, you will have to do the compounding manually.
This means that, just like other crypto users, you will need to re-invest your profit that you may earn daily or weekly on the crypto assets that you have already invested in so that you can earn higher profits on your crypto coins this way.
However, you should always research a lot more to find a reliable platform to use and invest in.
You should typically look for more comparable rates from other institutions and be knowledgeable about the differences.
This is because the numbers can be very tricky and misleading. Sometimes, even the lowest advertised rate of interest for a loan or highest advertised rate of interest for a crypto investment may actually prove to be the most expensive or least rewarding, as the case may be.
Conclusion
In the world of finance, both APR and APY are very important tools and concepts used. You will need to understand them well by knowing their differences in order to manage your personal finances. This article will be of huge help in that case.
I have special interest in crypto and intend to help common people to gain knowledge about the digital asset as well as its potential. Follow Me at Linkedin.
