Hello there hoomans! I just want to share about what I learned today about APR and APY. I know to most of you this is an old subject, but for some who are new to this, LIKE ME! Well here you go.
APR vs APY: The big difference is compounding
APR (Annual Percentage Rate),
is the interest rate on an account plus any fees you’ll have to pay. It’s calculated on a yearly basis and shown as a percentage. The essence of APR is a simple interest rate, so your profit depends directly on the original investment.
APY (Annual Percentage Yield),
is the rate you can earn on an account over a year and it includes compound interest. Compound interest, in contrast to the simple one, allows investors to get interest on interest, adding their profit to the initial sum of investment. For instance, in the DeFi world, you can get the rewards for staking and add them to the overall staked coins so that you receive higher profit next time.
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.
Let’s say you invest the same 1,000 coins as before but add compounding to the whole thing. If your compound interest is 10%, with daily compounding, you’ll get 1,105 by the end of the first year, 1,221 by the end of the second year, and 1,648 by the end of the fifth one. Moreover, the higher the interest rate and the more time you take, the better the outcome.
KEY TAKEAWAYS
APR represents the annual rate charged for earning or borrowing money.
APY takes into account compounding, but APR does not.
The more frequently the interest compounds, the greater the difference between APR and APY.