What’s the Difference Between APR and APY?
If you’ve ever used DeFi platforms or other financial tools, you’ve likely seen the terms APR and APY. They may look similar, but they’re not the same. Understanding the difference is important because it helps you decide which option really gives the better return. Let’s break it down.
APR (Annual Percentage Rate): Interest Without Compounding
APR is the annual interest rate without compounding. The calculation is always based on the original principal.
For example, suppose you deposit 100 THB with an APR of 10%.
End of Year 1:
100 + (100 × 0.1) = 110End of Year 2:
110 + (100 × 0.1) = 120End of Year 3:
120 + (100 × 0.1) = 130
And so on. The key idea: you always earn 10% of the original principal each year Common examples that use APR include Binance Earn and Uniswap Pools..
APY (Annual Percentage Yield): Interest With Compounding
APY includes compounding, meaning the interest you earn is added to the principal, and future interest is calculated on this larger amount. This creates exponential growth, like a snowball rolling downhill.
Example: deposit 100 THB with an APY of 10%, compounded once a year.
End of Year 1:
100 × (1 + 0.1) = 110End of Year 2:
110 × (1 + 0.1) = 121End of Year 3:
121 × (1 + 0.1) = 133
What if Compounded Monthly Instead?
Now suppose you have the same 100 THB deposit with 10% APY, but interest compounds monthly (12 times a year).
End of Year 1:
100*(1+(0.1/12))^12 ≈ 110.5End of Year 2:
100*(1+(0.1/12))^24 ≈ 122End of Year 3:
100*(1+(0.1/12))^36 ≈ 134.8
The more frequently compounding occurs, the faster the growth. Common examples that use APY include AAVE and Etherna.
Summary
APR = Annual Percentage Rate simple, fixed yearly rate, no compounding. APY = Annual Percentage Yield actual return with compounding, usually higher than APR. The difference lies in the letters R in APR = Rate (straightforward percentage). Y in APY = Yield (the actual compounded return).
Even if one product advertises a higher APR or APY, it doesn’t necessarily mean it’s the better choice. When comparing, you need to convert them into the same unit (there are many free online tools for this).
Also, consider the compounding frequency: for example, if two products have the same APY but one compounds monthly while the other compounds daily, the daily compounding option usually provides a slightly higher actual return.
In addition, always read the terms carefully and understand whether the advertised APY refers to compounding in tokens or actual yield in fiat currency. This distinction is crucial for accurately assessing the risk.