APY: how to read the Annual Percentage Yield in the crypto world

In the crypto markets, you often hear about APY (or APR), but what does it mean?

This is an acronym that does not refer to any cryptocurrency or token, although there are tokens with this name.

The acronym APY stands for Annual Percentage Yield, and its meaning should be well understood because it is not as straightforward as it might seem at first glance.

Summary

• The Annual Percentage Yield (APY)
• The Annual Percentage Rate (APR)
• The Variation of APY
• The Method of Cashing in Returns Generated by APY

The Annual Percentage Yield (APY)

Yield is an English term that means return.

For example, the yield of the 10-year U.S. Treasury bonds is identified by the ticker US10Y, where the Y stands for yield.

In the case of APY, the yield is calculated on an annual percentage basis, so the annual percentage yield is nothing more than the annual percentage of return.

For example, an APY of 10% means that the expected annual yield is 10%.

However, there are a couple of important characteristics of APY that require a bit of further exploration.

The Annual Percentage Rate (APR)

In addition to the APY, there is also the APR, or the Annual Percentage Rate. The latter does not measure the overall yield, but the percentage of the interest rate provided. It is also known as the simple interest rate.

In other words, when capital is locked, if the promised return is an APR, it will be sufficient to multiply the capital by the promised rate to calculate the annual return.

In the case of APY, the daily returns are collected and added to the principal, thus increasing the principal on which the interest is paid. In other words, the Interest in this case is compounded.

Therefore, a capital invested with an APR does not increase during the year, and at the end of the year, you will have the capital plus the interest accrued on that capital at the fixed rate indicated by the APR.

In the case of APY, the capital increases, generally day by day, when the returns are collected, which are gradually already disbursed. The APY is the total expected return including the interest accrued from the same previously collected interest.

In particular, the APY is useful for comparing different investment options, as it provides a more accurate and comprehensive measure of the return that can be obtained, also taking into account the frequency with which interest is calculated and added to the principal (something that does not happen with the APR).

The Variation of APY

When an APY is offered, it does not mean that the funds must necessarily be locked up for an entire calendar year to receive the expected return at the end of the twelve-month period.

APYs are the returns calculated as a percentage over an arbitrary period of one year, that is, twelve months, but they do not necessarily require immobilization for that period. Those who immobilize their funds in exchange for an APY can often withdraw them whenever they want, therefore the percentage return promised with APYs only concerns those who leave their funds immobilized for an entire year.

In general, such returns are not only paid at the end of the twelve-month lock-up period, but often day by day.

In this way, when you decide to liquidate the funds, you have already collected the yield up to that moment.

If the expected return is, for example, 10% per annum, the final APY should be 10%, but the return will most likely be paid day by day, obviously with lower percentages of about 1/365th of 10% per day.

However, the APY does not always remain constant over time. In other words, the yield actually paid often changes day by day, unlike, for example, fixed APRs that remain the same throughout the year.

Before locking up funds, it is necessary to understand whether the promised APY is fixed or variable.

The Method of Cashing in Returns Generated by APY

In addition to the variability of the APY, attention must also be paid to the method of collecting returns.

In general, they are usually paid in the same token that is invested and locked up.

That is, if you lock USDTyou will receive interest in USDT, but if you lock ETHyou receive in ETH, and so on.

This is very important to keep in mind, because if 1 USDT is always worth more or less 1 dollar (USD), the same cannot be said at all for cryptocurrencies or tokens that do not have fiat currencies as their underlying asset (with the exception of those of algorithmic stablecoins like DAI).

In theory, it would be much better to calculate such returns with the equivalent in fiat currency, otherwise, there is a risk of struggling to understand the real extent of profit.

For example, if you invest 100 USDT with an APY of 10%, at the end of the year you will have USDT worth approximately $110.

If instead you invest 100 token X, whose market value in dollars changes day by day, although in the end you will have 110 token X, it is not at all certain that these are worth 10% more than the initial 100 token X. In fact, almost certainly their value will have changed.

Imagining that the initial price was $1 per token, the initial market value of the 100 X tokens was $100, but if after a year their price had dropped to $0.5, the final value of the 110 X tokens would be only $55.

In light of all this, it is clear how the APY can seem like a simple concept, if not even trivial, while in reality its application is decidedly more complex, especially in the crypto field.

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