APR and APY in crypto: Definitions and how to calculate them

If you’re thinking about investing your cryptocurrency coins and tokens to generate even more, you’ll need to know a thing or two about interest rates. These can help you figure out how much you might earn over a period of time, and the bigger the better.

There are two important rates to be aware of, and these are APR and APY. In this AAG Academy guide, we’ll explain what each one means and the differences between them, and we’ll look at some examples that will help you better understand each one.

What is APR?

APR stands for “annual percentage rate,” and you’ve likely heard it mentioned before since it is widely used throughout the financial industry. Whether you’re applying for a credit card, loan, car finance, or an overdraft, you will have been informed about its APR. The term refers to the yearly interest generated on the amount of money borrowed or paid.

APR is conveyed as a percentage, which not only makes it easier to calculate, but it also allows borrowers and investors to quickly compare different financial products. A credit card with a lower APR is typically the top choice for borrowers, whereas the opposite is true for investors who are looking for the best possible return on their money.

APR typically takes into account any additional costs or fees, but it does not include compounding, which is when interest is added to a balance — like you might get with a checking or savings account. So, if you save $1,000 at an interest rate of 3%, and you don’t add any more, you’ll continue to earn interest on that initial sum, but not on the interest itself.

APR can be fixed, which means it does not change during the life of the financial product, or variable, which means it can change at any time. It’s also important to note that with certain products, especially credit cards, there can be different APRs for different things. For instance, purchases usually have a different APR to cash advances.

What is APY?

APY stands for “annual percentage yield,” and it works in much the same way as APR, except it does take compound interest into account. Because of that, APY on a loan, for instance, is higher than its APR because APY is calculated not only on the amount outstanding from the original balance, but also the interest generated during the life of the loan.

The higher the interest rate, and the more a balance might grow over time, the bigger the difference between APY and APR. The example outlined in the section below makes this a little easier to understand.

Because these rates are different, even on the same financial product, financial organizations have been known to emphasize whichever looks more attractive in their adverts, contracts, and other materials. A credit card company may show APR in a large font and APY in a smaller font, while a bank offering a savings account may do the opposite.

What is the difference between APR and APY in crypto?

APR and APY operate in much the same way within the cryptocurrency industry. So, if you were to lend cryptocurrency through a decentralized finance (DeFi) platform, the APR is the percentage you can expect to earn as interest on that investment, and it includes any fees the borrower needs to pay — but not the compound interest.

APY considers the principal amount borrowed, any fees the borrower must pay, plus compound interest. Therefore, APY is more profitable than APR for lenders, and more expensive for borrowers.

How to calculate APR with examples

It can be difficult to get your head around APR and APY — and especially the differences between them — without examples. So, let’s go over a couple of them here, starting with APR, to make everything a little easier to understand.

APR can be calculated by multiplying the periodic interest rate by the number of periods in a year in which it was applied. If you were to take out a $1,000 loan with a 12% APR, the balance of the loan would increase by 1%, or $10, every month. So, over the course of a year, an additional $120 would be owed. However, the APR does not change as the balance grows.

How to calculate APY with examples

Now, let’s say you take out a $1,000 loan with a 12% APY. The first month, the interest is 1% of the original balance, or $10. This would increase the balance to $1,010. The following month, the interest would be 1% of $1,010, or $10.10. The third month, the interest would be 1% of $1,020.10, or $10.201. The fourth month, the interest would be 1% of $1,030.301.

As you can see, although the percentage rate of APY remains the same, the actual amount grows over time because it takes compound interest into account. If you didn’t make any payments for the first year, the balance would grow to $1,126.83 (excluding any charges you might get for not making a payment), so the effective interest rate becomes 12.68%.

References

• Annual Percentage Rate (APR)
• What is apy
• Apy calculator
• How to calculate apr
• Apr vs apy whats the difference