Choose the right yield calculation method: Which is more beneficial for you, APR or APY?

Two concepts, a huge difference

When entering DeFi products, you will definitely come across two unfamiliar terms: APR (Annual Percentage Rate) and APY (Annual Percentage Yield). Many newcomers confuse these two concepts and end up suffering losses without even realizing it. In simple terms, the core difference between APR vs APY is that the former does not account for compound interest, while the latter includes this “magic.”

This is not a matter of nitpicking; choosing the wrong one could result in a profit gap of hundreds of dollars or even more.

APR: The Most Straightforward Interest Calculation

The annual percentage rate (APR) is the most basic method of interest calculation. You invest the principal and receive interest at a fixed rate each year, it's that simple.

Suppose you deposit $10,000 in a bank with an APR of 20%. After one year, you will receive $2,000 in interest, making the total in the account $12,000. In the second year, you will earn another $4,000 on the $12,000 principal (because the principal has increased), bringing the total to $14,000. In the third year, it will be $16,000. And so on.

This is linear growth - clear logic, but also the most “inefficient” way to make money.

Compound Interest: Let Money Work for You

Now let's take a look at the real magic that can double your earnings - compound interest.

The bank settles interest once a month, rather than giving it to you as a lump sum after a year. What does this mean? It means that the interest you earn in the first month will be included with the principal in the calculation for the second month. You are earning interest on your “interest.”

It's still the example of $10,000 with an APR of 20%, but this time the bank compounds monthly:

• The interest received in the first month will automatically be added to the principal.
• In the second month, you use (principal + first month's interest) to calculate the earnings.
• Continue in the third month, repeatedly compounding…

At the end of the whole year, you didn't end up with 2,000 dollars, but 2,429 dollars. The extra 429 dollars is the power of compound interest.

What if it were compounded daily? The result becomes $12,452. An additional $452. It doesn't seem like much, but if the time extends:

In three years, with the same APR of 20% and daily compounding, you will have $19,309. This is $3,309 more than simply calculating with APR. This is the real-life demonstration of the “Rule of 72” for compound interest.

The higher the frequency of compounding (daily compounding > monthly compounding > quarterly compounding), the greater the final returns.

APY is the actual yield you can achieve

This is the significance of APY (Annual Percentage Yield) - it converts APR into a “real number that already includes compound interest.”

Convert using the formula:

• APR 20% + Monthly Compound Interest = APY 21.94%
• APR 20% + Daily Compounding = APY 22.13%

These APY numbers are the actual percentage of returns you can get after one year.

Remember a trick: as long as the compounding frequency is greater than once per year, the APY will definitely be greater than the APR. APY is the real rate of return after the magic of compounding.

How to Compare in DeFi and Crypto Products

This distinction is especially important in the cryptocurrency market.

When you compare two DeFi lending products or cryptocurrency staking products, one labeled with an APR of 15% and the other labeled with an APY of 16%, you can't simply say “I choose the one with the higher APY.” You must first confirm whether their compounding periods are the same.

Both products are labeled with APY, but one is daily compounding and the other is monthly compounding. Therefore, the one with daily compounding will ultimately yield a higher return—even if the APY numbers don't seem to differ much.

More importantly, it's essential to understand what this APY/APR refers to. Some DeFi products use APY to represent token rewards, not fiat returns. When the price of this token plummets, even though you see a high APY on-chain, the actual returns when converted to dollars may be negative.

This is why some people buy into a “100% APY” yield farm and end up losing money. You earned tokens, but the tokens depreciated.

Core List for Selecting Income Products

1. Unified units for comparison: Convert all products to APY, so it's “comparing apples to apples”.
2. Confirm Compound Interest Period: With the same APY, daily compounding > monthly compounding
3. Understand the underlying assets: Is the APY return in fiat currency or tokens? Is there a risk of token depreciation?
4. Understand the details of the terms: Product risks, lock-up periods, and penalties for early withdrawals—all will affect actual returns.
5. Conduct Your Own Stress Test: If the token price drops by 50%, is your “high yield” still worth it?

Final Words

APR vs APY may seem like just a game of two acronyms, but they actually represent the fundamental difference between simple interest and compound growth. One is a banking mindset, and the other is a mathematical mindset.

In the world of crypto and DeFi, the power of compounding is amplified – it can mean high returns, but also high risks. Always remember: higher APY comes with more complex product mechanisms, and higher risks often lurk within. So while chasing yield numbers, spending more time understanding the essence of the product is true wisdom.

Risk Warning: The digital asset market is highly volatile. The value of your investment may rise or fall at any time, and you may even be unable to recover your principal. You are fully responsible for your investment decisions. Please ensure that you fully understand the terms and risk factors of the relevant products and make an independent judgment before investing.