APY & APR: The 2 Main Methods To Measure Interest In The Crypto World
When comparing digital assets we usually see percentage rates under acronyms like APY and APR. They are similar terms, and they both have to do with interest rates. But what exactly are they? Why are they important? What makes them different from each other? Read on to learn more!
What is APY & APR?
APY (annual percentage yield): the amount of interest earned on your savings.
APR (annual interest rate): the amount of interest you owe.
Since APR gives you the idea of the cost you’ll obtain with a credit card or loan, you want that number to be as low as possible. For APY, on the other hand, you’ll expect to see how much interest you could acquire from a potential account or investment, which means you want the APY to be as high as possible.
What are the differences between APY and APR?
Both APR and APY measure interest. However, if APR measures the interest charged, APY measures the interest earned. So, while both of them are two important terms to understand regarding interest rates and claim to be true reflections of money owed or earned, both leave out some fees.
APR is usually linked to credit accounts. The lower the APR on your account, the lower your overall cost of borrowing might be. Whereas APY is usually linked to deposit accounts. The higher the APY on your account, the higher your earnings might be. Just remember that your earnings may also depend on how much money you have in your account, not just APY.
How are APY & APR calculated?
Both APY and APR are used to calculate the interest for investment and credit products, significantly impacting how much you earn or have to pay when they are applied to your account balances.
However, going deeply, APY and APR are not created equally. For beginners, APY takes into account compound interest, neither does APR.
According to Investopedia:
APR = Periodic Rate x Number of Periods in a Year
APY = (1+Periodic Rate)Number of Periods -1
How do APY & APR work?
The ‘annual’ in APR doesn’t mean you only pay your loan once a year. Instead, you can pay it monthly or an even more frequent payment schedule based on your loan. APR differs from simple interest rate as it contains an amount of fees on top of the interest rate. APR does not also consider compound interest. So, while APR is advertised as the true cost of borrowing, it is not all-encompassing and will likely be lower than the amount you need to pay back on an annual basis.
APY is used mostly by banks or other financial institutions in order to inform clients about the amount of interest they earn on their principal, which can frequently be found on their savings accounts. Unlike APR, APY accounts for compound interest rates. However, APY does not consider any fees, as it is in the bank or financial institution’s best interest to have this number appear as high as possible to win your business. In the crypto world, APY works the same way. Users can earn compound interest on their cryptocurrency by keeping them in savings accounts, staking the tokens, and yield farming by supplying the liquidity to liquidity pools. Such interest-bearing activities are available through cryptocurrency exchanges, DeFi protocols, and Dapps. In general, users can earn interest in the same cryptocurrency as what they deposited.
Understanding the power of compound interest will help you build your wealth and avoid financial debt. When you know how APR, APY and the true cost of interest data works, you can search for the best option on your terms!
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Disclaimer: The information herein is for educational purposes only and should not be considered financial, investment, or trading advice. Please conduct your own research and due diligence before making investment decisions. You understand that you are using the Information provided at your own risk.