APR vs. APY: What’s the Difference?
APR and APY are standards by which interest for borrowing and lending financial products. They are closely related and always mixed up because they determine how much you will pay or earn when applied.
Because one involves compound interest and the other doesn’t, understanding the difference between them, and how to calculate each, will help you make good decisions when borrowing or lending assets.
The first step in understanding APR and APY metrics is understanding compound interest.
Compound Interest
“Compound interest is the eighth wonder of the world; he who understands it earns it; he who doesn’t, pays it”. — Albert Einstein.
In simple terms, compound interest involves earning interest on added interest. This means already earned interest is added periodically to the initial amount of a deposit or loan, and more interest is earned on that.
What is APR?
APR (Annual Percentage Rate) is the annual rate of return — expressed as a percentage — before factoring in compound interest.
Example:
if you invest 1,000 coins with a 10% yearly interest rate, you’ll get 1,100 coins by the end of the first year, 1,200 coins by the end of the second year, and 1,500 by the end of the fifth one. Of course, this does not include any applicable fees. Yet, your investment will steadily grow by about 10% from the original investment every year.
However, when it comes to APY, the situation radically changes.
What is APY?
APY (Annual Percentage Yield) is the annual rate of return — expressed as a percentage — once you factor in compound interest. You’ll run into this most often when considering deposit accounts, and how much you’ll earn on your deposit.
APR example:
For example, if you invest $1,000 with a 80% yearly interest rate, you’ll get $1,800 by the end of the year. Of course, this does not include any applicable fees. Yet, your investment will steadily grow by about 80% from the original investment every year.
However, when it comes to APY, the situation radically changes.
APY example:
To give you a better idea, we’ll provide an example of an APY as well. Let’s say you invest the same $1,000 as before but add compounding to the whole thing. If your compound interest is 80%, with weekly compounding, you’ll get $2,212 by the end of the year. Moreover, the higher the interest rate and the more time you keep compounding, the better the outcome.
Some crypto products that use APY refer to the rewards you will earn on that particular cryptocurrency, not fiat rewards. Crypto prices are always volatile — meaning that the fiat value of your investment may go up or down.
