APR vs. APY: Why the Small Difference Affects Your Wealth

Anyone who navigates the world of Crypto inevitably stumbles across two terms: APR and APY. Both describe returns, but that is where the similarity ends. The difference between APR and APY can lead to massive yield differences over the years – and many investors do not even understand what trap they are falling into.

What is this actually about?

Imagine this: You deposit 10,000 USD in a savings account with a 20% APR. After one year, you have earned 2,000 USD – that’s the simple calculation. But here’s the crux: APR is like the gross figure on food products. It tells you how much interest you theoretically receive per year, without the complicated details.

The APY, on the other hand, is like the net calculation. It takes into account something called compound interest – and that is the game-changer.

The Compound Interest Phenomenon Explained

Compound interest is “interest on interest”. Sounds abstract? A practical example makes it clear:

With monthly compounding, you won't just receive 2,000 USD at the end of the year, but rather a portion of it transferred to your account each month. In the next month, you will earn interest not only on your original capital but also on the interest you have already received. Thus, your capital grows exponentially.

Let’s stick to our example: 10,000 USD, 20% APR, monthly compounding. After one year, you will have not 12,000 USD, but 12,194 USD. The difference: 194 USD extra from compound interest.

Now it gets interesting: If the interest is calculated daily instead of monthly, you would end up with 12,213 USD. After three years with daily compounding? 19,309 USD – that’s 3,309 USD more than without the compound interest effect. The frequency of compounding thus determines your final wealth.

Understanding the Calculation: APY

This is exactly where the APY comes into play. It is the “real” return that you earn with compound interest. With a 20% APR and monthly compounding, the APY is 21.94%. With daily compounding, it is 22.13%. These percentages show you the annualized return including the effect of compound interest.

Mnemonic: APR is always a fixed amount. APY varies depending on how often interest is credited. The more frequently, the higher the APY.

Why this becomes critical in comparisons

Here is where most mistakes happen: You compare two crypto products, one with 18% APY and the other with 19% APR – and think that the second one is better. But that can be completely wrong.

Scenario: Product A has 22% APY (daily interest), Product B has 20% APR (no compound interest). Product A looks lower, but generates you significantly more yield.

This is especially true for DeFi products and staking offerings from various providers. Some calculate with compound interest, others do not. Some pay out in Crypto, some in fiat. The crucial point: Before comparing, you must bring both values to the same basis.

The Crypto-specific Risk

There is still a catch with crypto products: Often the APY is calculated in cryptocurrency, not in fiat. It sounds like the same thing – but it is not.

Let's assume you earn a token with a 25% APY. But the price of this token plummets by 40%. Your yield in crypto has increased, but your wealth in euros or dollars has still shrunk. That's the flip side of the coin: high APY does you no good if the underlying value collapses.

Therefore, it is essential to read the exact terms. Which currency is used for the APY calculation? How often is interest compounded? What hidden fees are there?

The conclusion for your portfolio

APR and APY are not interchangeable terms. APR is the simple basis, while APY is the more realistic figure when compounding interest is in play. And with most modern products – whether savings accounts, staking, or DeFi – they are.

The golden rule: Always compare apples to apples. Use converters when necessary, and make sure that both products are evaluated on the same APY or APR basis. Only then will you truly see which product brings you the most. And don't forget: In the crypto world, return risk always comes with volatility risk. Higher APY is enticing – but not without reason.