What Is Annualized Percentage Yield (APY) in Crypto?

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According to Bankrate, the average bank savings interest rate in the U.S. is 0.06%. With traditional savings rates hugging the floor, it’s not surprising that crypto savings accounts, staking, yield farming and crypto lending are getting considerable attention. After all, who wouldn’t want to earn passive income?

Annual percentage yield (APY) is a common term used in traditional finance, as well as in crypto, to explain how much you can earn from your assets. The main difference usually lies in whether your returns are compounded — i.e., whether your earnings themselves generate earnings — and over what time period. As a crypto investor, APY is a key metric to help you compare returns between platforms or assets. 

This article will explain the concept of APY, how it works in crypto, and the investment opportunities where APY matters.

What Is APY?

APY is the annualized rate of return from an investment, factoring in compound interest that accrues or grows with the balance. Compound interest includes interest earned from the initial deposit, plus the interest earned on that interest.

Although commonly associated with traditional savings, APY is a crucial metric for crypto savings programs and works similarly. Crypto investors can earn APY on cryptocurrencies by staking them, putting them in savings accounts, or providing liquidity to liquidity pools via yield farming. 

You can quickly get started earning APY on your crypto through cryptocurrency exchanges, wallets and DeFi protocols.

Typically, investors will earn interest in the same cryptocurrency as that in which they’ve deposited. However, there are instances where they can be paid in the same or a different currency.

Simple Interest Rate vs. Annualized Percentage Yield

While APY refers to the projected rate of annual return gained on a deposit or stake after accounting for compound interest, a simple interest rate only considers the interest earned on the original stake. Thus, the main difference is that APY takes into consideration the effects of compounding interest if it applies. 

Compounding is a powerful investment tool since it enables you to earn additional income over time. Compound interest is calculated over a certain period, and the added value is added to the balance. With each additional period, the interest paid on the overall balance also increases.

To make it easier to understand, consider staking $1,000 at an interest rate of 12% per annum in January 2021. After one year in January 2022, using a simple interest rate calculation, you’ll receive a total of 1,000 × (1 + 12%) = $1,120.

The same $1,000 staked at 12% per annum, but with biannual compounding of interest in the first six months, will give you 1000 × (1 + 6%) = $1,060, or the total after six months.

After a year, you’ll earn 1,060 × (1+ 6%) = $1,123.60 

That extra $3.60 comes from the power of compound interest. Therefore, your annualized percentage yield is the return you’ll receive over the year: $1,123.6 ÷ $1,000 − 1, or 12.36%.

How Does 7-Day APY Work in Crypto? 

The 7-day APY is an annualized yield using 7-day returns. It’s calculated by taking the net difference in price from 7 days ago and today and generating an annual percentage. 

The formula to calculate 7-day APY is as follows:

APY = (X − Y − Z) ÷ Y × 365/7

Where:

X = the price at the end of the 7-day period

Y = the price at the start of the 7-day period 

Z = any fees for the week

This calculated amount helps investors to understand the weekly yield or return.

Does APY Represent Final Earnings?

APY represents your rate of return or the amount of profit or earnings you can make. Depending on how long you choose to stake your coins, your ultimate earnings will differ. The holding period will determine how much you actually earn. 

How to Calculate APY in Crypto

APY measures the rate of return earned annually as a profit on any sum of money or investment after factoring in compounding. 

The formula for calculating APY is as follows:

APY = (1 + r/n)  − 1

Where:

r = periodic rate of return (or annual APR)

n = number of compounding periods each year

The calculation of APY in crypto is the same as it would be in traditional finance, and the goal is similarly to come up with a percentage yield.

However, there are other ways of calculating APY depending on the exchanges. For example, Bybit offers flexible staking that allows users to stake tokens and unstake them anytime to collect yields they are guaranteed for without the element of compounding interest. The APY is calculated in a simple interest format where the daily yield represents the interest rate that will be deposited into your wallet depending on the number of tokens you’ve staked. 

The formula is as follows:

Daily yield = The number of total tokens staked × (APY for the staked token ÷ 365)

For example, if you’ve staked 10,000 USDT for guaranteed APY at 9%, you can collect a rounded-off to the nearest integer of 2.5 USDT the next day. The calculation is represented as 10,000 × (0.09 ÷ 365) = 2.4657 USDT.

However, if you’ve chosen to unstake your tokens after collecting the daily yields, there will be no yield credited to your account. Essentially, any changes to the initial staked asset will affect the daily yield. 

What Is the Annual Percentage Rate (APR)? 

APR, or annual percentage rate, is the interest you earn from your invested assets in a year, expressed as a percentage. This figure may include fees that borrowers pay. It’s a useful tool for comparing different investment products since it provides a consistent basis for presenting annual interest rate data. 

APY and APR sound very similar. However, unlike APY, APR doesn’t factor in compounding.

For example, if you stake 10,000 coins at an APR of 10%, you’ll earn 1,000 coins as interest after one year. But with APY, the situation changes significantly. 

To calculate APR, you can use the following formula: 

APR = [(Fees + Interest) ÷ Principal] ÷ n × 365 × 100 

Where:

P = principal investment 

N = number of days in the term

In traditional finance, APR is often used to discuss terms for borrowers, for instance, the credit card interest rate that borrowers must pay. This percentage rate of interest can also refer to the percentage paid to investors. In general, the APY for a loan is higher than its corresponding APR because of the effects of compounding.

Factors That Influence Crypto APY

Inflation

Inflation refers to the loss in value of a currency over time. Within crypto, inflation refers to the process of adding new tokens to the blockchain network, usually at a predetermined rate. The appeal of cryptocurrencies such as Bitcoin is that they’re designed to have predictable and low inflation rates. 

The rate of inflation for a particular network affects the staking returns. If your coin experiences inflation rates higher than your APY, then your earnings are eroding just as quickly as you’re adding them.

Supply and Demand

As with any market economy, the law of supply and demand influences pricing. An owner of a cryptocurrency can effectively lend their crypto to generate interest income. Since interest is earned based on the demand to borrow that crypto, market dynamics can determine the rates. 

The interest rate charged for borrowing money tends to be lower when there’s plenty of supply, and higher when it’s scarce. Similarly, crypto APY is variable, changing according to the level of demand for and liquidity of each coin.

Compounding Periods

The calculation of the APY is also influenced by the amount of compounding applied, which can vary. Remember, APY increases if the number of compounding periods increases. 

Let’s look at an example. If you deposit $100,000 compounded monthly at 5% per annum, your APY will be 5.116%. The calculation used is 100,000 × (1 + 0.05 ÷ 12)^(12). Your balance will be $105,116 by the end of the year. 

On the other hand, if compounding is done on a daily basis, then your final balance will be $105,127 with a 5.126% APY by the end of the year. The calculation used is 100,000 × (1 + 0.05 ÷ 365)^(365).

The more opportunities your interest has to grow, the more it can earn. 

Crypto Investments That Involve APY

If you’re the HODLing type, then you don’t have to just store your crypto in a wallet and wait for it to appreciate.

There are ways to invest your crypto and draw on the magic of compound interest or APY in order to grow and multiply your assets.

Crypto Lending and Borrowing

If your target time horizon in crypto is for the long term, you can get a lot more mileage out of your holdings with crypto lending.

Crypto lending works pretty much the same way as traditional lending, but without all the red tape and paperwork. In addition, you’re lending cryptocurrency rather than paper money. When you give out your crypto on a decentralized platform to borrowers, you earn interest or crypto dividends. Depending on the platform, the interest rates can range from 3% to 17%. 

While crypto lending provides investors with a passive income stream, borrowers also benefit from enjoying additional liquidity. 

Crypto Borrowing

Let’s say you have 10 BTC, and you need some cash urgently — but you don’t want to sell any of your cryptos because you believe the value will go parabolic in the future. You fear that if you offload your Bitcoin, you could end up with less crypto when you repurchase it at a later date. 

So what can you do?

Crypto lending platforms will allow you to use your 10 BTC as collateral and receive a loan. But note that you may have to “overcollateralize,” a fancy way of saying you’ll have to lock in far more crypto than the amount you want to take as a loan. 

When you repay your loan in full, your collateralized BTC will be returned — and if the market favors you, that BTC may have appreciated.

Crypto Lending

Lending platforms connect crypto lenders to borrowers. Here’s how crypto lending works:

A borrower requests a loan from a lending platform. Once the platform approves the request, the borrower must stake some of their cryptos as security for the lending. The lender funds the loan and receives interest payments periodically at the agreed APY. This continues until the end of the loan tenor.

The borrower returns the entire loan amount, and only then is the collateralized crypto returned.

Investing in crypto lending is straightforward. First, find a good lending platform. There are two types: decentralized and centralized platforms. Smart contracts run the decentralized lending platforms without any intermediation. In contrast, centralized platforms involve a third party that manages the lending process. 

Before signing up with a lending platform, please do your due diligence and ensure it’s reputable. Then confirm and compare the offered APY to get the most out of your digital assets.

Yield Farming

Yield farming refers to proactively lending your crypto assets to make more crypto. Yield farmers move their assets around different marketplaces in search of the highest yield and treat the approach like a trading strategy. The most successful yield farmers are constantly tracking APY and taking advantage of the most lucrative opportunities. Yield farmers typically earn far higher rates than they would from saving fiat currencies in the bank.

Crypto Staking

Crypto staking is a method of earning rewards with your crypto by confirming cryptocurrency transactions on a blockchain network. Essentially, you can generate your income on PoS networks that bring stakeholders together to verify the network. Not only are you securing the network, but you earn crypto in the process.

The more coins you commit to the network, the more likely you’re chosen as a validator to add blocks to the blockchain. Unlike crypto mining, you don’t need any special hardware to earn rewards. When you stake, you lock up your crypto, taking it out of circulation for a defined period. This effectively limits the supply of the coin, which can also positively impact its value.

What Can You Do with Earned Interest? 

Earned interest goes into your portfolio as profits earned with relatively little work. This is the definition of a passive income. You can keep trying to earn more interest on that income, or you can take the earned interest and use it for trading. The cryptocurrency market is ripe with opportunities to trade spot crypto and derivatives. 

Trading spot crypto means buying and selling cryptocurrencies at current market rates on an exchange. You can also trade derivatives, which are financial contracts whose value is based on an underlying cryptocurrency. Derivatives contracts like futures and options offer additional ways to access and trade cryptocurrencies.

Of course, you can also take that earned interest and use it as a store of value. As a store of value, that crypto is expected to maintain its purchasing power for use at a later date. Famous stores of value have included gold, which is why the most popular cryptocurrency, Bitcoin, is often referred to as “digital gold.” In derivatives trading, value is estimated by an underlying asset. The underlying asset can be a cryptocurrency, too. 

The Bottomline

Every investor needs a method of comparing investment opportunities and calculating how much profit they’ve made. APY, or annual percentage yield, is a standard calculation of the rate of return used in traditional finance as well as crypto. It includes the effects of compound interest, which can increase the amount earned. The higher the APY, the more money investors make. Comparing your APY options can help you to figure out your most attractive investment opportunities.

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