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TLDR:
Understanding the two terms of APR and APY becomes even more important in DeFi today, as nearly all protocols with yield farming fields display these numbers. Knowing them well is not only for understanding and executing different strategies and calculating real profits.
General Conclusion
APR and APY are used in many yield farming programs in DeFi protocols. However, they are not the same thing! We, the participants in the market, are not only investing but actively receiving yields by farming and staking DeFi tokens. So these basic terms are not only important, but they are also information that helps you to invest more effectively.
Both are related to returns. But how are they different? Why are they not interchangeable? We discuss that in today's newsletter.
Definition
APR stands for Annual Percentage Rate. It is the actual annual rate of return, NOT taking into account the effect of compound interest.
APY stands for Annual Percentage Yield. It is the actual annual rate of return, taking into account the effect of compound interest.
Who uses what? APY is better to calculate your returns on investment while APR is more common in lending.
Quick math: which do you think is higher? APY, the one that considers compounding.
What Are They Different?
APR
For example, a yield farming program offers an APR
of 100%/yr. You use $1000 to join this program. One year later you will receive $2,000, where $1000 is the initial capital and $1000 is APR
.
Once you see the APR, it is possible to immediately calculate how much profit will be earned at the end of the period. This profit comes from your staking or farming, so just join at the beginning to get the result for APR interest.
Formular
APR = r x N
Where:
r: The interest rate of the year;
N: Interest period (N = 1, means 1 year).
APY
APY is another way of calculating the percentage of real profit you will receive.
What will you get if you receive profit every day from staking and you will add that to your principle and earn interest on that every day?
If you have an APR
of 100%/yr with getting daily profit, you have to divide APR
by 365 days to calculate the interest received daily (0.27%). Then reinvest this interest continuously every day. The amount you get is $2,714.57, where $1000 is the initial capital and $1714.57 is APY
.
Assuming you participate in farming pairs on Solana's Raydium application, I also combine Step Finance to know the APR
and APY
of these farming pairs. Typically, I am staking $RAY on Raydium (current project APR is 35.33%), with $1,000 you farm at the beginning of the year to the end of the year, the total income will be $1,423.51.
Formular
APY = (1+r)^n – 1
In which:
r: The interest rate of the period;
n: Interest period (n=1 means 1 day).
Awareness
As such, today's projects often offer 2 ratios of APR and APY to show users what the rate of return is currently available. However, some projects that give daily, 7-day interest rings directly provide APY. This has two implications:
- First, displaying APY
will produce a larger percentage than APR
, making brave people feel that they will receive more profit. - Secondly, the APY
interest is only true if the user reinvests (restake, refarm) continuously in the allowed period (e.g. when receiving rewards, immediately stake).
Today we see a lot of aggregator protocols already using this ability to increase profits, continuously reinvesting within the capacity of the original protocols. This is really good if the transaction costs are not significant. Hopefully, we can find those solutions in Layer 2.