APY stands for annual percentage yield. It is a way to calculate your compounded return every year as a percentage figure. It is common for those staking in DeFi pools and other crypto banking products to earn interest on their coins. It is one of the best ways to earn passive income with cryptocurrency.
What Is APY? – Definition & Meaning
APY stands for annual percentage yield. It is a common term used throughout traditional finance and measures how much interest you can earn from your assets. APY is the annualized rate of return from your crypto investment, factoring in compound interest that accrues with the balance. Compound interest refers to interest earned from the initial deposit and the interest earned on that interest.
While the term annual percentage yield is commonly thought of with traditional savings vehicles, it’s also a significant metric to pay attention to for crypto savings platforms. It works similarly to the conventional banking sector in that sense. Crypto investors can stake cryptocurrency and earn APY. The two most common ways are to put them in a savings account or provide liquidity to liquidity pools via yield farming. Think of it as a way to earn passive income with your cryptocurrency.
How to Calculate APY on Crypto
The simplest way to calculate the yield based on APY is to multiply the APY value by the principal amount.
If you wish to break down APY into a specific timeframe, such as a week or a month, there is an easy formula to calculate how much interest you will earn. For example, let’s say that you have a 5% APY 30-day plan that you had initially deposited 1,000 USDT into.
The interest = (Principal x APY / 365) x Period
Calculation = (1,000 x 0.05 / 365) x 30
Monthly interest = 4.1095 USDT
As you can see, you gain a little over 4 Tether per month. Through the magic of compounding, the longer you keep your crypto deposited, the more your return ends up being. The idea of compounding is compelling when the crypto was going to be sitting dormant anyway.
If you were to redeposit after 30 days, you would simply replace the original 1,000 of the calculation with 1,004.1095. Over the next 365 days, you would end up with 1,050 Tether.
What is 7-Day APY in Crypto?
In traditional banks, interest is usually compounded every month. However, most crypto platforms will offer shorter compounding periods, with 7-day being one of the most common. There are a lot of reasons to choose a shorter compounding timeframe, such as:
- Higher volatility: Cryptocurrencies tend to be extraordinarily volatile, so some investors choose shorter compounding periods to allow them to mitigate the effects of price swings on the underlying crypto.
- No manipulation: Investors can ensure that the annual percentage yield is the same as the one advertised by the financial institution and that no manipulation takes place over the long term.
- Newbies: Newer investors tend to prefer shorter compounding periods because they are unsure whether engaging in crypto is for them. This allows them to “try it out” before getting into the markets too deeply.
There are other time frames that people use. The 14 and 30-day options are pretty popular, and in all of these, APY is still calculated based on yearly numbers. Some platforms will allow you to earn without limitations on the length of your deposit.
What is a good APY for Crypto Deposits?
APY earned by depositing crypto is much higher than that of a traditional savings account. Most cryptocurrency projects offer an APY of over 1%. It’s not uncommon to see coins that are in more demand, perhaps ones like Tether, bring in 7% APY. Furthermore, you don’t necessarily have to lock your crypto up on some platforms.
Some projects offer extraordinarily high APYs of over 100%, usually on DeFi platforms, but you should note that not all projects are fundamentally sound. Because of this, due diligence is essential, especially with the higher-yielding projects, with the adage “If it sounds too good to be true, it probably is.”
APY vs. Traditional Investments
APY in traditional finance is significantly lower than what is offered in crypto wealth management platforms. Multiple reasons for them include:
Banks have a wider spread, meaning that on an investment that pays 0.25%, they will typically charge 3% or more on loans made with that money. APY can easily reach 6% in cryptocurrency accounts, as loans are typically between 6% and 8%.
There are fewer regulations in the crypto space, which can drive APR higher. Furthermore, there is a significant amount of volatility in the crypto world, so investors demand more for their deposits.
Institutional players dictate overall interest rates in the crypto world. Higher APR and APY come from the bigger risks associated with the space. While deposits offer more interest, loans are more expensive as well.
What Is the Annual Percentage Rate (APR)?
The annual percentage rate, or APR, is the interest you earn from assets in the year, expressed as a percentage. The figure can also include fees that borrowers pay, giving an overview of performance. It’s a tool for comparing different investments because it provides a consistent basis to compare annual interest rate data.
An example of APR would be if you had an APR of 7%, you would earn 700 coins on a 10,000 coin deposit at the end of one year. APR can be calculated with the following formula:
APR = [(Fees + Interest) + Principal] / days x 365 x 100
Often, APR is used to discuss terms for borrowers and traditional finance. An example would be credit card interest rates, but this percentage rate can also refer to the percentage paid to investors.
The Difference Between APY and APR
If you are on the lending side of a transaction, whether through a decentralized platform or investing in a savings account, you will be looking for the highest APY. This is because APY allows for compounding as you go. On the other hand, if you are on the borrowing side of the transaction, you will be looking for the lowest APR, which means you’ll be paying less interest on your loans.
APR rates that are fixed are doubtful to change. However, if you sign up with a loan that has an introductory APR, you will need to know how long it lasts and what your rates will be once the introductory rate ends.
APR reflects the simple interest rate over a year, while APY covers the compounding interest, where you earn interest on your interest.
Factors That Influence Crypto APY
Multiple factors come into play with the annual percentage yield available to crypto holders. Much like traditional finance, there are some external factors outside of the realm of crypto, as well as internal ones.
Inflation and its Influence
Inflation is a big issue regarding savings, regardless of the market you are discussing. Inflation refers to the loss of value in a monetary unit over time. In the crypto world, inflation refers to adding new tokens to the blockchain network, which is typically predetermined. The appeal of some cryptocurrencies is that they are designed to have low inflation rates.
The rate of inflation for the network that you are dealing with will have a significant influence on staking returns. In high inflation environments, the inflationary destruction of value could be higher than your APY. This is why it’s essential to understand the inflation rate of whatever coin you are dealing with.
Supply and Demand and its Influence
All markets have to pay attention to supply and demand, and cryptocurrency markets are no different. If a coin is in high demand, the interest earned typically is higher, and vice versa. The interest rate charged for borrowing crypto tends to be lower when there’s plenty of supply and higher when it is scarce. Crypto APY is variable, changing according to the level of demand and the liquidity of each coin.
Compounding Periods Matter
The amount of compounding applied influences the calculation of the APY of your investment. This can vary, and APY increases if the number of compounding periods increases. In other words, the more often something is compounded, the larger it grows.
If you were to deposit $10,000 compounded monthly at 5% per annum, your APY would be 5.116%. It is not 5% because it’s done 12 times. The calculation is $10,000 x (1 + 0.05 ÷ 12) ^ (12). Your final balance would be $10,511.60 at the end of the year.
If compounding is done daily, your final balance will be $1512.70 with a 5.126% APY by the end of the year. The calculation is as follows: 10,000 × (1 + 0.05 ÷ 365) ^ (365).
Crypto Investments That Involve APY
If you are a long-term cryptocurrency holder, it makes sense to take advantage of the ability to earn passive income. If you have no plans to sell your holdings in the foreseeable future, there are plenty of solutions to generate interest and finance other areas of your life.
Borrowing
While most people focus on the ability to earn interest on your crypto, borrowing is also possible. If you have crypto and need to take out a loan, it is possible to use that crypto as collateral without selling it.
If you own Bitcoin or another crypto, you can borrow against it. Perhaps you believe that over the long run, your coins will appreciate greatly, so you do not want to sell them. You can go to a crypto lending platform and receive a loan. The lender may have you “overcollateralized,” meaning that you may have to deposit more crypto than the loan is worth.
Someone might do this because they believe that once they pay back the loan and receive their crypto back, it will be worth more in the future. Think of it much like a home equity loan, as you are putting up a highly valuable asset, understanding that you will pay the loan back and that over time the house should be worth more.
Lending
Lending platforms are used to connect lenders to borrowers. A borrower will request a loan from a lending platform. Once the platform approves the request, the person borrowing will stake their crypto as security for the loan. The lender receives interest payments just like a typical banquet. Once the borrower returns the entire loan amount, they receive their collateralized crypto back.
If you wish to invest in crypto lending, it is straightforward. There are two types of lending platforms, decentralized and centralized. Decentralized lending platforms use smart contracts without intermediation. Centralized platforms involve a third party that will manage the process.
Platforms will have different APY offerings, so make sure you do your due diligence to get the most out of your digital assets. The smart contract will automatically return your interest payments with a decentralized platform.
Yield Farming in Crypto
Yield farming is proactively lending your crypto to make more crypto. Those who choose to yield farm move their assets to different platforms in search of higher interest yield and treat the entire process like a trading strategy. The downside is that you will need to constantly track APY to take advantage of the most lucrative opportunities. That being said, yield farmers, more often than not, will earn much higher rates than they would from a traditional savings account.
Crypto Staking for Returns
Staking crypto is a method of earning rewards with your crypto by confirming transactions on a blockchain network. You generate income from your crypto on a proof-of-stake network that has stakeholders verifying the network. You are not only securing transactions in the network, but you are earning more crypto in the process.
While it will vary from network to network, the more coins you commit to your network of choice, the more likely you will be chosen as a validator to add blocks. Once you add blocks to the blockchain, you receive a reward. You do not need any special hardware to earn rewards, but when you stake, you lock up your crypto, taking it out of circulation for a defined period of time.
What Are the Advantages of APY?
Annual percentage yield can be a great way to earn extra in the crypto world, mainly because of a handful of massive benefits, including:
- Frequency of compounding: As opposed to other forms of interest, APY considers the compounding interest while other forms of interest metrics don’t necessarily do the same.
- Crypto can appreciate: Unlike traditional fiat currency, cryptocurrency can appreciate quite drastically in value; therefore, your interest payments may have more purchasing power as the coin arises.
What Are the Risks of APY?
The risks involved in trying to obtain an annual percentage yield in crypto will vary from platform to platform, but there are a couple of things you need to pay attention to:
- Volatility: Volatility is one of the most significant benefits to crypto because it can appreciate so quickly. However, crypto also goes in the other direction, meaning that over time your initial deposit could be shrinking in value, which in turn makes the interest payments shrink.
- Still new: The crypto world is still new, and there have been lenders who have run into problems. Because of this, a certain amount of risk is involved, including losing your deposit. Make sure any platform you deal with has maintained a strong reputation.
Conclusion
The biggest question to ask yourself is whether or not you plan on doing anything with your crypto. If you are not, then there’s no real reason to ignore the ability to earn passive income. This is one of the best parts of dealing with crypto; you can lend and borrow without an intermediary.
One concern that you do need to keep in mind is that it is possible the coin that you are staking could depreciate. If it falls fast enough, you can wipe out any gains you would have received via interest. However, if you are a long-term holder, you understand that crypto markets fluctuate wildly at times, and the idea is not how much the crypto is worth in fiat terms but how much you can accumulate.
You need to understand that the crypto world is still evolving, and it’s very likely that as time goes on, the interest you can earn on crypto probably begins to drop. After all, as there is more adoption, there will be much more supply out there, and the question will be whether or not demand can keep up? However, the reality is that the yield earned in crypto is far superior to traditional finance.
How does APY work on crypto?
Annual percentage yield, or APY, acts as a savings account for your crypto. It is similar to the Annual percentage rate account you will find at a bank. You deposit your crypto in a fund of the DeFi platform and receive a fixed rate of return in that same coin.
What does 5.00% APY mean?
5.00% APY means that you are earning 5% interest annually. For example, if you had deposited 100 Cardano in a DeFi solution and were to get 5% annual interest, after 12 months, you would have 105 Cardano.
What does APY mean in crypto staking?
Annual percentage yield refers to the percentage rate of the total stake that is rewarded for doing so. It is the return after 12 months. For example, if you have an APY of 8% and stake 1,000 Solana, you would receive 80 Solana as a reward, giving you a total of 1,080 Solana.
Which crypto gives the highest APY?
This is constantly changing based on supply and demand. Quite often, some pools are trying to get established and willing to pay more, but this puts your cryptocurrency further out on the risk spectrum.
Why is crypto APY so high?
Demand for many coins, especially stablecoins, often exceeds the available supply. Because of this, those looking to borrow are often willing to pay high rates.
What is a good APY?
It depends on how you look at it, but one thing is for sure: traditional banks aren’t offering anywhere near enough yield in a savings account to beat inflation. When choosing an investment for yield, it is crucial to understand that there is a balance between yield and viability. If the coin drops precipitously, the yield will not be able to keep up with your losses. Also, make sure you understand the inflation rate when selecting the program. It must be higher than your country’s inflation.
