By Larry Wright
If you have an interest in cryptocurrencies, you have probably been familiar with the terms APR and APY at some point in the past and pondered what these terms really mean. Are these two things one and the same, or are they distinct? You are not alone in your confusion about the distinction between these two concepts that are very closely connected to one another.
The following guide essay serves as a primer on the subject of crypto lending and borrowing, outlining the essentials of understanding both of these concepts and their significance.
Interest from various forms of cryptocurrency investments or repayments is often expressed as either an annual percentage rate (APR) or as an annual percentage yield (APY). The expenditures may include but are not limited to the provision of cash to volatility groups on platforms, staking, yield farms, cryptocurrency deposit accounts, and maybe much more.
There is a possibility that you might accrue interest on a number of these securities depending on the APR percentage, whereas others calculate the payment using the APY approach.
Recognizing the distinction between annual percentage rate (APR) and annual percentage yield (APY) is essential for every cryptocurrency enthusiast who seeks to direct their capital toward the most lucrative revenue opportunities prevailing in the present contemporary money market.
It is essential that you have a thorough understanding of the manner in which the interest on any loans or investments that you make will be computed. The Annual Percentage Rate, sometimes known as the APR, and the Annual Percentage Yield are the two primary techniques (APY) that are widely utilized, and so they are essential for you to understand.
Here is another quick rundown of what they actually are, how they function, how economic organizations and banks use them to offer lending and investment services, and how you’ll determine whether they’re right for you.
What is APR or Annual Percentage Rate?
The proportion or amount of money that is paid back in return for a loan is referred to as the annual percentage rate (APR). It is calculated on an annual basis and is also commonly known as an interest rate for traditional credit card payments.
For example, if the annual percentage rate (APR) is 10%, then a purchase of $1,000 will result in a payment of $100 a year afterward. If, on the other hand, one borrows $1,000 using the same interest income for a period of one year, then both the original $1,000 loan and the $100 accrued in credit must always be returned.
Knowing the calculation of the APR provides a snapshot of the amount that is going to do when taking out loans as well as the amount that an entrepreneur will receive when his money is paid back. When using a credit card, the annual percentage rate (APR) is normally not levied; nonetheless, the amount is assumed to be cleared off on or before the given deadline of each month.
Nevertheless, in the event that there exists an amount that is still owed after the payment deadline has passed, interest will be applied at the conclusion of the next invoicing month.
The annual percentage rate (APR) is the percentage that investors may anticipate as their earning in the form of interest upon their venture, for borrowing their bitcoin or any other cryptocurrency, or providing it for borrowing. This is referred to as the “expected return” on an asset.
It takes into account the borrower’s obligation to reimburse any extra charges, although it does not incorporate the interest accrued on compounded balances. The principal, interest rate, borrowing period in days, penalties, as well as other charges are all inputs needed to determine the annual percentage rate (APR) of a credit.
Keep in mind that the annual percentage rate (APR) only accounts for basic interest and doesn’t factor in compounding throughout the year. It is typical for loans with a short repayment period, such as financing options, consumer lending, and certain kinds of mortgages, and usually the ones which are paid back within a year.
It is important to look at the annual percentage rate (APR) as well as the rate of interest whenever comparing different loan packages offered by banks and other monetary organizations.
When you submit an application for credit, the creditor is essentially the one who decides what rate of interest should be given to you, and this interest rate would be precisely what would determine your APR. However, what should be noted is that the rate of interest that the customers are charged is also influenced by a variety of other variables, some of which may be very significant.
When determining what interest rate to provide you, creditors will probably take into consideration a number of criteria, one of which is your credit rating or score. For the exact same loan, a person who has good credit ratings is expected to receive a cheaper lending rate compared to somebody with poor credit scores; this is supposing that all of the remaining criteria remain the very same.
Also, the interest rates may differ from lender to lender even if you are signing up on the very same day with the very amount. That is why it is often to one’s advantage to browse about and see which lender is providing the most desirable interest rate; the lower, the better.
The annual percentage rate is determined by administrating the standard rate of interest to the whole underlying value of a fund or mortgage. Because the APR is indeed an annualized rate, the payment on an investment that is secured for a short period of time will be determined or calculated using a fractional method.
For illustration purposes, an investment that is held for six months and has an annual percentage rate of 10% will only return 5% of the upfront outlay.
Let us now understand APR using Bitcoin as an example. Suppose that you place one of your Bitcoins (BTC) in some kind of a borrowing pool working on a decentralized finance (DeFi) infrastructure. If the annual percentage rate (APR) is labeled to be 12%, you would be granted an additional 0.12 Bitcoin, given you lock away your Bitcoin for an entire year and don’t use it for any trading activities.
With the addition of the interest collected (at 12% APR), the initial Bitcoin commitment should now be worth 1.12 Bitcoin (1 BTC plus 0.120 annual interest bitcoin you earned).
What are the Two Main Types of APR?
It is essential that you be aware of the sort of APR that applies to your loan. You will most likely have either a fixed annual percentage rate (APR) or a variable annual percentage rate (APR). When a loan’s annual percentage rate is said to be fixed, it indicates that the APR will not fluctuate in response to changes in an underlying index over the course of the loan’s duration.
For example, if you are promised a 12% interest on your bitcoin holdings at the beginning of the year, the rate would remain the same throughout all the months. When it involves creating financial plans, having a set annual percentage rate (APR) could be more reliable. The majority of foreclosures and consumer loans typically have set annual percentage rates (APRs).
Variable annual percentage rates, on the other end, are subject to fluctuation and are linked to an index interest rate. One example of this kind of rate is the primer rate that is reported in the famous Wall Street Journal. Given the situation, if the prime rates were to climb, the variable APR would therefore rise too, and don’t forget that vice versa can occur too.
The annual percentage rates (APRs) on variable loans may either work in your favor or even against yours as it is really dependent upon the underlying index value. This particular sort of APR is frequently observed on credit cards.
What is the Annual Percentage Yield (APY)?
The actual rates of profit produced on a property are referred to as the annual percentage yield (APY). In other words, it is the amount of profit you’ll earn when you lock away any of your assets like bitcoins or any other cryptocurrency of your choice for any period of time.
This crucial element is calculated by taking into consideration the impact of compounding interest, which differs significantly from simple interest and is computed on a routine basis when new balances are instantly contributed to the principal amount.
Because the portfolio total increases somewhat with each passing month, the amount of interest that is accrued on balance also increases with every passing day. A certificate of deposit (CD), a portion of the stock, or a bond fund are all examples of investments that are evaluated, in the end, by the rate of income that they provide.
The rate of return is defined as the proportion of increase that an investment has seen over a certain amount of time, most often one year. The more the number of years, the more would be your final earnings. However, if several assets have various compounding periods, it might be challenging to determine the rates of profit offered by each of those securities.
If you want to compare rates of return between two or more assets, you can’t just look at the percentages over one year since it doesn’t take into account the impact of compound interest. It is of the utmost importance to be aware of the frequency of the amplification process, given that the rate of an investment’s return is proportional to the frequency with which it is increased.
This is because each time it accumulates and grows, the interests generated during that term are contributed to the principal sum, and subsequent interest installments are computed based on that bigger main sum.
Contingent on the kind of savings accounts one has, the annual percentage yield (APY) may either be variable or fixed. The annual percentage yield on a savings or cash marketplace deposit is almost always subject to change. This indicates that it is linked to a reference rate that serves as a baseline, just like the way APR is calculated.
Your annual percentage yield can go up or down depending on whether the baseline rate goes up or down. The interest offered by savings accounts almost always change in response to developments involving the federal reserve rate. However, the annual percentage yield that you get from CDs is almost always predetermined in advance.
A certificate of deposit (CD) is a kind of time-term deposit, which means that you make a commitment to retain your dollars in consideration for a certain amount of time. In return, you will get a predetermined interest rate on the CD as opposed to a fluctuating interest on loans again until CD achieves its repayment schedule.
The annual percentage yield (APY) of your account is a major predictor of the earning potential of your deposits. You may get a pretty good idea about how much income you’ll receive depending on the amount in your portfolio by taking into consideration the annual percentage yield (APY), which is calculated employing the compounding interest.
The annual percentage yield calculator enables it simple for investors like yourself to estimate your monthly earnings and improves your ability to budget your income statement on a constant schedule. Additionally, you may see the effortless growth of your savings thanks to compound interest.
Differences Between APR and APY
I am sure by now you are well aware of the two terms and how they work. Let’s have a quick look at their differences. When calculating the interest on cryptocurrency borrowing and securities, both the annual percentage yield and the annual percentage rate are employed.
On the other hand, they do not constitute the same thing and are significantly distinct from one another. The difference between the yearly percentage yield and the annual percentage seems to be the interest received or payable each year.
When attempting to compare the APR and APY interests, the most crucial difference is the compound interest. All those other aspects, including fundamental balance, the cost of borrowing, and the specific period of time, an expenditure is held, are similar.
However, it’s the compound interest that draws the line between the two. Since APY takes compound interest into consideration, yields from APY are significantly higher than those from APR.
Crypto investors have the choice to employ their Crypto in whatever way they choose. They can trade with their crypto coins, preserve their investment holdings in bank deposits, finance liquidity pools on marketplaces, or even invest in yield farms as per their preferences.
No matter what approach you are considering picking, recognizing the distinction between the annual percentage rate (APR) and the annual percentage yield (APY) is essential if you want to make the most out of your investments.
However, there is one thing I would really like to highlight, and that is how the implication and meaning of APY vary from one crypto investment to another. This is a really important element to ponder over. When it comes to certain commodity and security collaterals, the word “APY” doesn’t really mean anticipated or actual profits or yielding, but rather the incentives that one may receive in terms of cryptocurrencies when one makes an investment.
This is a key difference to note since the amount of your purchase (in terms of actual currency) might go upwards or downwards based on the cost of cryptocurrency exchanges.
However, given a situation where your crypto market hits turbulence and significantly decreases in value, the worth of what you’ve deposited, in regards to fiat currency, could still be smaller than the initial fiat money you had deposited, even if you keep receiving an annual percentage yield (APY) on a consistent schedule.
This shows that APY may not be able to compensate for your losses in case of market turndown, and that is something you should really remember.
Because of this, it is essential that you read the pertinent security policies and terms thoroughly, as well as do your independent investigation before making any final investments. This is to ensure that you have a complete understanding of the economic dangers that are associated with your investment and what precisely the APY implies in that particular setting.
Conclusion
APR and APY are two similar but confusing terms. While the APR offers a decent foundation of what it would cost you to lend Crypto or any other asset from a lender in terms of the quantity of money you have to pay back, the APY gives a much better image of how you would profit if you were to lend or lock your bitcoins or securities for a specific period of time.
Though the elements impacting APR and APY are identical, it is the compound interest that discriminates one from the other. Nevertheless, they are two crucial ideas in the crypto domain, and you must have a comprehensive understanding of each.