According to Bankrate, the average bank savings interest rate in the U.S. is 0.06%. With traditional savings rates hugging the floor, it’s not surprising that crypto savings accounts, staking, yield farming and crypto lending are getting considerable attention. After all, who wouldn’t want to earn passive income?
Annual percentage yield (APY) is a common term used in traditional finance, as well as in crypto, to explain how much you can earn from your assets. The main difference usually lies in whether your returns are compounded — i.e., whether your earnings themselves generate earnings — and over what time period. As a crypto investor, APY is a key metric to help you compare returns between platforms or assets.
This article will explain the concept of APY, how it works in crypto, and the investment opportunities where APY matters.
What Is APY?
APY is the annualized rate of return from an investment, factoring in compound interest that accrues or grows with the balance. Compound interest includes interest earned from the initial deposit, plus the interest earned on that interest.
Although commonly associated with traditional savings, APY is a crucial metric for crypto savings programs and works similarly. Crypto investors can earn APY on cryptocurrencies by staking them, putting them in savings accounts, or providing liquidity to liquidity pools via yield farming.
You can quickly get started earning APY on your crypto through cryptocurrency exchanges, wallets and DeFi protocols.
Typically, investors will earn interest in the same cryptocurrency as that in which they’ve deposited. However, there are instances where they can be paid in the same or a different currency.
Simple Interest Rate vs. Annualized Percentage Yield
While APY refers to the projected rate of annual return gained on a deposit or stake after accounting for compound interest, a simple interest rate only considers the interest earned on the original stake. Thus, the main difference is that APY takes into consideration the effects of compounding interest if it applies.
Compounding is a powerful investment tool since it enables you to earn additional income over time. Compound interest is calculated over a certain period, and the added value is added to the balance. With each additional period, the interest paid on the overall balance also increases.
To make it easier to understand, consider staking $1,000 at an interest rate of 12% per annum in January 2021. After one year in January 2022, using a simple interest rate calculation, you’ll receive a total of 1,000 × (1 + 12%) = $1,120.
The same $1,000 staked at 12% per annum, but with biannual compounding of interest in the first six months, will give you 1000 × (1 + 6%) = $1,060, or the total after six months.
After a year, you’ll earn 1,060 × (1+ 6%) = $1,123.60
That extra $3.60 comes from the power of compound interest. Therefore, your annualized percentage yield is the return you’ll receive over the year: $1,123.6 ÷ $1,000 − 1, or 12.36%.
How Does 7-Day APY Work in Crypto?
The 7-day APY is an annualized yield using 7-day returns. It’s calculated by taking the net difference in price from 7 days ago and today and generating an annual percentage.
The formula to calculate 7-day APY is as follows:
APY = (X − Y − Z) ÷ Y × 365/7
X = the price at the end of the 7-day period
Y = the price at the start of the 7-day period
Z = any fees for the week
This calculated amount helps investors to understand the weekly yield or return.
Does APY Represent Final Earnings?
APY represents your rate of return or the amount of profit or earnings you can make. Depending on how long you choose to stake your coins, your ultimate earnings will differ. The holding period will determine how much you actually earn.
How to Calculate APY in Crypto
APY measures the rate of return earned annually as a profit on any sum of money or investment after factoring in compounding.
The formula for calculating APY is as follows:
APY = (1 + r/n)ⁿ − 1
r = periodic rate of return (or annual APR)
n = number of compounding periods each year
The calculation of APY in crypto is the same as it would be in traditional finance, and the goal is similarly to come up with a percentage yield.
However, there are other ways of calculating APY depending on the exchanges. For example, Bybit offers flexible savings that allows users to stake tokens and unstake them anytime to collect yields they are guaranteed for without the element of compounding interest. The APY is calculated in a simple interest format where the daily yield represents the interest rate that will be deposited into your wallet depending on the number of tokens you’ve staked.
The formula is as follows:
Daily yield = The number of total tokens staked × (APY for the staked token ÷ 365)
For example, if you’ve staked 10,000 USDT for guaranteed APY at 9%, you can collect a rounded-off to the nearest integer of 2.5 USDT the next day. The calculation is represented as 10,000 × (0.09 ÷ 365) = 2.4657 USDT.
However, if you’ve chosen to unstake your tokens after collecting the daily yields, there will be no yield credited to your account. Essentially, any changes to the initial staked asset will affect the daily yield.