Annual Percentage Yield (APY)Share

What Is Annual Percentage Yield (APY)

Annual Percentage Yield (APY) is a measure of the real rate of return earned on an investment over a year, considering the effects of compounding interest, expressed as a percentage. Unlike simple interest, which is calculated only on the principal amount, APY includes the interest earned on both the principal and the accumulated interest. This makes APY a more accurate reflection of the potential earnings over time.

APY is commonly used in both traditional and decentralized finance (DeFi) platforms, staking, yield farming, and other cryptocurrency investment strategies. It helps investors understand the potential profitability of their investments, allowing them to make more informed decisions.

How Is the Annual Percentage Yield Calculated?

The formula for APY is:

APY = [(1+r/n)^n] - 1

Where r is the nominal interest rate and n is the number of compounding periods per year. This formula accounts for the interest earned on both the principal amount and any accumulated interest, which distinguishes it from simple interest calculations that only consider the principal.

For example, if an investment offers a nominal interest rate of 5% compounded monthly, the APY would be higher than 5% because the interest is compounded 12 times a year. The more frequently the interest is compounded, the higher the APY due to the interest-on-interest effect.

Annual Percentage Yield (APY) vs. Annual Percentage Rate (APR)

It's important to distinguish Annual Percentage Yield (APY) from Annual Percentage Rate (APR). While APY includes the effects of compounding, APR does not. As a result, APY will always be equal to or higher than APR for the same nominal interest rate. When evaluating investment options or loan costs, it's crucial to compare APY to APY and APR to APR for an accurate comparison.