There are many concepts and terms in the field of cryptocurrencies that investors constantly confront. Each of these terms plays an essential role in shaping the digital asset investment landscape.
APY (Annual Percentage Yield) is no exception. It is the fundamental indicator determining the potential crypto investment’s return and profitability.
In this blog post, we’ll delve deeper into APY, uncovering its meaning, importance, and role it has in determining returns. In addition, we will reveal the calculations and examine the factors that influence APY.
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What is an annual percentage yield (APY)?
APY stands for Annual Percentage Yield, and it refers to the actual interest rate earned from an investment yearly. It considers account compound interest, which involves the overall sum of both initial deposit and its accrued interest.
Essentially, APY helps track how much compound interest grows over time. In general, it is a passive income you can earn by staking cryptos, providing liquidity, or putting them in savings accounts.
How to calculate APY?
APY, or annual percentage yield, can be calculated in various ways depending on the context. A general formula exists for calculating APY, which is:
APY = (1 + r/n)^n – 1
r – the annual interest rate expressed as a decimal.
n – the number of compounding periods per year.
This formula considers the compounding effect of interest. Unlike simple interest, which stays constant, you calculate account compounding interest at regular intervals, and the earned interest is directly added to the initial investment.
With each passing period, as the investment grows due to accumulated interests, so do the payments based on this higher amount.
In the case of cryptocurrencies, the APY may vary according to the specific exchange or platform. You can calculate the daily yield in a very simple way. You have to multiply the total number of tokens by the APY of the token at stake and divide it by 365.
However, even the frequency of the different compounding periods impacts APY. It increases the more compound interest you calculate.
When you calculate the APY of a cryptocurrency, you bear in mind that inflation, supply and demand, and the liquidity of the cryptocurrency affect it. If inflation is high, the real value of your earnings may decrease.
What is APY in crypto?
If you understand how APY works in traditional finance, you will have no problem when it comes to cryptocurrencies.
Cryptocurrency investors can also earn interest on their crypto APY, by building their cryptocurrencies, holding them in savings accounts or providing funding for liquidity pools through yield farming.
The APY of an eme shows the return on investment. When you calculate APY, take into account compound interest. In contrast, the simple interest rate is calculated considering only the interest earned on the initial deposit.
Investments that compound interest more often grow faster. The value of the initial deposit increases more quickly so that subsequent interest payments calculated based on this increase are higher.
Every investor needs to assess the expected return on a deposit. The APY indicator makes it easier to compare the returns of different investments with different accumulation periods and, therefore, it helps to make optimal decisions.
In the field of cryptocurrencies, APY is particularly valuable. It allows the growth of cryptocurrency investments to be assessed over time, bearing in mind the ever-changing nature of cryptocurrency yield products.
Given this dynamic characteristic, APY helps to discern the potential growth of crypto investment and make informed decisions.
Crypto investments that earn APY
Some cryptocurrency holders (HODLers) are holding their crypto assets and taking advantage of the potential price increase. Others, however, are actively looking for ways to maximise the return on their digital assets.
One strategy is a bet, where investors allocate a certain amount of their cryptocurrency holdings to be blocked and withdrawn from circulation for a predetermined period. This method influences the overall supply of a cryptocurrency, thereby affecting its value.
Another method is yield farming, where you lend your crypto assets to others. Yield farmers travel through different markets, moving their assets according to the potential return offered.
To be successful in income farming, it is necessary to monitor the annual percentage yield (APY) to identify the most profitable opportunities available. APY is a metric for assessing the potential return on investment and helps crop farmers make informed decisions on where to allocate their assets to achieve the best results.
7-day APY meaning in crypto
The 7-day APY is a valuable tool for investors to estimate the annualised yield based on 7-day returns. Taking the net difference between the current day’s price and the price 7 days ago gives an annualised percentage to quantify the weekly yield or return.
By calculating the 7-day APY, investors gain an understanding of the weekly yield or return of their investments. It is a concise measure of the performance of their assets over a shorter period.
While an APY calculator can help to determine the annual return, you should note that the accuracy of such calculators may be affected by the terms of the platform’s betting policy and the actual returns offered. Therefore, you should be cautious and aware of the following factors when calculating APY.
Factors that influence crypto APY
- Inflation
Inflation plays a crucial role in determining APY fluctuations in the market of cryptocurrencies. It can refer to the loss of value of a currency over time and to the process of adding new tokens to the blockchain network at a predetermined rate.
Cryptocurrencies such as Bitcoin have predictable and low inflation, which increases their attractiveness. The level of inflation in the network affects the return on stakes. If a coin’s inflation rate exceeds the APY, investors’ earnings fall as fast as they accumulate them.
The inflation rate of a given blockchain network impacts the profitability of stakes and the rewards received by individual users. When investors stake their tokens with blockchain managers, they receive new tokens as a reward. Therefore, a higher inflation rate in a given blockchain network means a higher APY.
- Supply and demand
Supply and demand play a role in determining cryptocurrency prices and APY. When it comes to lending cryptocurrencies for interest income, the borrowing demand of a particular cryptocurrency influences rates of interest.
Due to market dynamics, the APY of cryptocurrencies may vary depending on the liquidity and demand level.
In the cryptocurrency market, the APY varies depending on the level of demand for the token and its liquidity. Generally, high token demand corresponds to a high APY. If an investor earns more than 10% by lending an asset, it indicates that other market participants are willing to pay interest rates above 10% to borrow that cryptocurrency.
New projects launched on decentralised exchanges (DEX) often offer high APYs. It is due to the high volatility of the token price in the early stages of the project. It ultimately increases the probability of potential losses.
By offering a high APY, these projects aim to compensate for any potential losses and attract users to provide liquidity rather than sell their tokens. However, as more market participants offer liquidity and the value of the project stabilises, the APY offered by these tokens usually decreases.
- Compounding periods
The APY calculation takes into account the applicable compound interest rate, which may have an impact on the final result. Increasing the number of compound interest periods results in a higher APY. Thus, the more opportunities for compound interest to grow, the higher the potential earnings.
Similarly, the number of compounding periods is also essential in determining the overall APY.
Consider that you have deposited a cryptocurrency worth USD 100 000. Assume it bears an annual interest yield (APY) of 10%. If you calculate compound interest daily, the APY will be 10.51%, resulting in a balance at the end of the year of USD 110 510.
However, if you calculate it monthly, the APY will decrease slightly to 10.47%, resulting in a balance of USD 110 470 at the end of the year.
What is the annual percentage rate (APR)?
The annual percentage rate (APR) is the yearly interest rate expressed as a percentage of the invested assets. This indicator allows you to compare different investment products. It provides a consistent basis for presenting annual interest rate data.
Unlike APY (Annual Percentage Yield), the annual percentage rate does not consider compounding.
What is the difference between APY and APR?
APY and annual percentage rates are standard interest rates expressed as annual percentage rates. However, they have some key differences.
APY is often used in the cryptocurrency market as it considers compound interest, and reinvestment of profits and provides an estimate of potential returns. APR, on the other hand, does not take into account compound interest and is more useful for fixed figures.
The APR includes fees and additional costs associated with the investment transaction, whereas the APY calculates only the interest rate. They provide a more detailed understanding of investment return and compound interest when used together.
Simple interest vs compound interest
Compounding interest and simple interest are two different ways of calculating investment returns.
Simple interest must be calculated only on the initial investment amount and must not take into account interest earned over time. It remains a fixed rate that does not change with the calculation of subsequent interest.
By contrast, when calculating compound interest, you should consider both the principal amount and the accrued interest. When you add interest to the principal, you calculate subsequent interest based on the new, higher balance. This compound interest effect allows the total investment to grow faster than simple interest.
Consider the frequency of compounding periods when comparing the returns of various investments with different accumulation periods. More frequently accumulated investments, such as daily or monthly, may grow faster due to the more frequent interest added.