APR vs APY: What’s The Difference?
The terms are very similar and both are related to interest rates. But one letter can make a huge difference.
Personal finance can get tricky — at some point, you probably thought that APR and APY are pretty much the same things. Well, you are fortunate to have found this article, because such ignorance can cost you a lot of money.
So what exactly are APR and APY?
APR stands for annual percentage rate and refers to the interest rate applied to the principal amount of an investment or loan. The ambiguity begins here because APR represents different things in traditional banking and crypto.
APR in Everyday Life
In general finance, APR is used to calculate the interest rate you are charged for borrowing money. It’s also known as a credit card interest rate and is generated yearly.
In daily life, you will most often meet this abbreviation used in the context of credit cards and loans of all sorts. Here APR will mean the amount of interest that you as a borrower must pay each year (to the bank, for example). The lower the APR, the less you may have to pay in interest.
APR in Crypto
The picture changes considerably when we pass to the crypto sphere.
In cryptocurrency, the APR is used to calculate the interest you as an investor can expect to earn for lending your crypto or making it accessible for loans.
The APR is very straightforward and is exclusive of compounding interest, which we will discuss below. To calculate the APR, you can use the following formula:
Put simply, a 10% APR means 10% is earned on the initial investment after a year. An investment of 10,000 coins at a 10% APR will accrue 1,000 coins in interest after a year.
APY stands for annual percentage yield. It represents the rate of return you’ll earn on an investment, taking into account the effect of compounding interest.
Compound interest is the main concept in talking about APY. In a nutshell, compound interest means earning interest on the previous interest. Every time the computation is updated, the interest should be added to the sum comprising the initial investment and the accrued interest profits.
APY, or annual percentage yield, incorporates interest compounded with a certain regularity. The effect of compounding can work miracles for you when investing in crypto for yield.
How is APY calculated?
The inclusion of compounding interest makes calculating APY more complex, as it takes into account the number of periods at which the amount is adjusted based on the interest rate. To calculate the APY, you can use the following formula:
Put simply, an investment of 10,000 coins at a 10% APY with two recalculation periods at 6 months and 12 months will accrue 1,025 coins in interest after a year.
In Search of the Greatest Benefit
Summing up all the above, we see that APY is a certain winner. Unlike the APR, which only considers ordinary interest, the APY includes compound interest, which makes it much more profitable, other things being equal. Investment at 10% APY will eventually bring you more money than the same investment at 10% APR.
Another point that you should pay attention to is the compounding frequency. The more often interest is compounded, the higher your returns will be. 10% APY with monthly compounding will bring you more money than 10% APY with quarterly compounding. At HEXN we went further and decided to offer our users weekly compounding — unique terms for making crypto savings at the moment.
Also remember, that the power of compounding is more impressive over more extended periods, as your deposit will become larger with each compounding. So, investing your money at the APY rate may become a good groundwork for your earnings in the years to come.