APY (Annual Percentage Yield) is the effective annual return incorporating compound interest, widely used in DeFi protocols for staking, liquidity mining, and lending. Unlike simple interest, APY reinvests earned interest periodically, leading to higher cumulative gains.
Simple vs. Compound Interest: A Practical Example
With $100 at 10% annual simple interest, you earn $10 in one year. Under semi-annual compounding, the first six months yield $5 interest; the second six months earn $5.25 on $105 principal. Total return is $10.25 — an APY of about 10.25%. The extra $0.25 shows the power of compounding.
APY Calculation Formula
APY = (1 + r/n)^n – 1, where r is the periodic rate (APR) and n is the number of compounding periods per year. For example, with r=55.44% and daily compounding (n=365), APY ≈ (1+0.5544/365)^365 – 1 ≈ 74.02%. Higher compounding frequency widens the gap between APR and APY.
Key Factors Affecting Crypto APY
Earnings depend on platform rates, asset type, supply-demand dynamics on DeFi platforms, lock-up periods, and fees. Some platforms offer promotional APYs that may drop later — community trustworthiness matters. Common scenarios: staking ETH (4–6% APY), liquidity provision on ETH/USDT (10–20% APY), crypto savings in USDC (8–12% APY), and lending BTC (3–7% APY).
APY vs. APR: What’s the Difference
APR (Annual Percentage Rate) ignores compounding, typically used for loans to show actual borrowing cost. APY includes compounding, making it attractive for savings. For an APR of 10% compounded semi-annually, APY is about 10.25%. The difference grows with higher rates and more frequent compounding.
Benefits and Risks of Crypto APY
APY in crypto can reach 5–15% or higher, far exceeding traditional savings, enabling passive income and diversified strategies. However, price volatility may undermine nominal returns; platform hacks or regulatory changes pose real risks; some products impose lock-ups that limit liquidity.