Earning interest income from cryptocurrency investments is becoming a popular way to earn money. This approach is often associated with the APY indicator in cryptocurrency. In this review, we will tell you how to correctly calculate this indicator, how to use it in practice, and what risks associated with APY to avoid.
Content:
- The Magic of Compound Interest
- What does APY mean?
- How to calculate APY in cryptocurrency in 5 minutes?
- Online calculator for calculating compound interest
- Where can I find information about APY quickly and easily?
- What is the difference between APY and APR?
- Risks People Forget About When Talking About APY
- New Possibilities for Using APY in Cryptocurrency
- Conclusion
The Magic of Compound Interest
Before we start talking about annual percentage yield, it is worth understanding such concepts as simple and compound interest. Simple interest is considered to be a fixed rate, the amount of payments at which depends on the size of the initial deposit. In this case, the money earned in the previous period is not taken into account for subsequent calculations.
At the same time, compound interest is an accrual method in which income is calculated not only on the initial deposit amount, but also on previously accumulated interest. As you might guess, thanks to compound interest, your savings will grow much faster than when using simple interest. To verify this, let's look at a few examples.
First, let's remember the formula for calculating simple interest:
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Simple Interest = Initial Deposit x Interest Rate x Time |
Where 'Initial Deposit' is the amount of investment, 'Interest Rate' is the annual interest rate, and 'Time' is the investment period. Let's imagine that we invested $1000 on the Binance exchange in the Binance USD (BUSD) stablecoin at 10% per annum for three years. Then the amount of profit earned will be:
$1000 x 0.1 x 3 = $300
Thus, in three years we will be able to withdraw $1300 from the exchange, which you will agree is not bad. However, as we know, everything is learned in comparison. Therefore, let's compare: how much could we earn on compound interest over the same period?
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Compound Interest = [Initial Investment × (1 + Interest Rate) ^ n ] – Initial Investment |
'Initial Deposit' is an investment amount, 'Interest Rate' is an annual interest rate, 'n' is the number of interest accrual periods.
To make the comparison correct, we invest the same amount - $1000 at the same interest rate - 10%, for the same 3 years, only we will reinvest the interest received annually. Then the amount of profit earned will be:
[$1000 x (1+0.1)^3] - $1000 = $331
As we can see, taking into account the compound interest, we will earn more. And the more often and longer we reinvest our capital, the higher the return we will receive taking into account the compound interest.
What does APY mean?
Let's note right away that the term APY (Annual Percentage Yield) does not apply exclusively to cryptocurrencies. It comes from finance and shows how much you can earn in one year on investments taking into account compound interest.
As we have already seen, compound interest adds earned profit to the initial balance, after which future interest calculations are made on a larger amount of capital. Thus, the more often interest is calculated, the greater the impact it will have on our balance.
For crypto investors, the APY metric is important because its value indicates the potential return on investment. Since this metric is so important, it’s time to figure out how to calculate it correctly.
How to calculate APY in cryptocurrency in 5 minutes?
This can be done quite simply using a formula that calculates the return on investment after taking into account compound interest:
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APY = (1 + r/n)ⁿ − 1 |
Where:
r – nominal rate of return (in fractions of a unit),
n – the number of compound interest periods.
At first glance, this formula may seem complicated. To better understand how it works, let's look at a specific example. Let's say we placed (locked) a certain crypto asset at a nominal rate of 10% per annum with the possibility of daily interest accrual. All we need to do to calculate APY is to substitute the necessary values into the formula:
APY = (1 + (0.1 / 365))^365 - 1 = 10.52%
This result means that the effective annual return on this investment is approximately 10.52%, not 10% as one might think looking at the nominal rate.
Online calculator for calculating compound interest
For your convenience, we have created a widget that can easily calculate APY using the formula above. In the first line of the widget, you must specify the annual interest rate, and in the second line, the number of compound interest periods, then click the "Calculate" button.
Compound Interest Calculator
Following our example, we will indicate the annual interest rate - 10%, and in the second line we will indicate the number of periods - 365, since in our case the interest is accrued daily. After clicking the "Calculate" button, we will get 10.52%.
Where can I find information about APY quickly and easily?
If the above calculations are not enough for you, use one of the online services that calculate these indicators taking into account trading platform commissions, variable interest rates and many other factors.
One of them is DefiLlama, which calculates not only the APY but also the TVL (Total Value Locked) and the total market capitalization of stablecoins.
In addition to it, the Staking Rewards service is very popular. It shows the calculation of profitability for a day, month and year, as well as graphs of profitability for simple and compound interest.
For example, the NRG token can yield a 59.5% annual interest rate at the nominal interest rate and 79.87% compounded.
What is the difference between APY and APR?
When investing in cryptocurrency, you will often come across APY and APR. Both reflect the return on your investment. However, it is important to understand the difference between them, as they lead to different results due to different calculations.
As mentioned above, APY is the annualized yield taking into account compound interest, while APR (annual percentage rate) is the yield at the nominal rate without taking into account compound interest. As a rule, investors use the APY metric to evaluate long-term investment projects, and the simpler APR metric to evaluate the performance of short-term loans.
It is worth keeping in mind that APY is usually higher than APR. And the more often compound interest is calculated, the greater this difference. Therefore, do not focus solely on analyzing APR, as this can lead to a significant underestimation of the profitability of your investments.
Risks People Forget About When Talking About APY
When calculating APY in cryptocurrency, do not forget that this indicator itself does not guarantee profit. Often, very attractive figures hide risks that are not usually discussed, but they should be remembered. First of all, this concerns market volatility . Due to the high volatility of asset prices, APY can also change significantly. When prices fall, any investment will depreciate even with a very high APY, do not forget about this.
Also, if you have staked your cryptocurrency, tempted by the high APY, remember that it will be locked there for the period of investment. During this time, you will not be able to sell it or exchange it for any other digital asset. Also, use only reliable and proven platforms . There are many fraudulent sites on the Internet that attract inexperienced investors with sky-high annual yield percentages. Most of them are fake or, at the very least, unsafe.
New Possibilities for Using APY in Cryptocurrency
Initially, the APY indicator was used to assess the profitability of bank deposits and bonds. However, with the development of technology, it began to be used more actively in cryptocurrencies. Most often, the annual interest rate taking into account compound interest is used to assess the profitability of staking - blocking the user's cryptocurrency for the needs of the blockchain , for which he receives a certain reward.
With the rise of decentralized finance (DeFi) and the emergence of new investment projects in the lending, borrowing, and savings space such as Aave, Compound, Celsius, MakerDAO, and Yearn Finance, the APY metric has come to be used to evaluate these opportunities.
However, the most innovative way to use APY in cryptocurrencies has been to use it in “Yield farming” calculations – a strategy for increasing investment returns by redistributing capital across multiple DeFi protocols. For example, you can invest 15% of your crypto assets in Aave, 35% in Compound, and 50% in Yearn Finance to diversify risks.
Conclusion
Every investor is looking for a simple and at the same time effective way to compare investment opportunities. APY in cryptocurrency is one of them. The annual percentage yield allows not only to compare different projects, but also to understand the level of income that can be obtained from a specific project in the case of regular reinvestment.
The widespread development of technology and the improvement of decentralized finance have opened up fundamentally new opportunities and strategies for using investment performance evaluation tools. At the same time, we urge you to be careful and remember that any evaluation of investment projects, including those using APY in cryptocurrency, is associated with risk. Carefully study and compare different options in order to determine the most attractive investments.
See also:
How to buy cryptocurrency for rubles or dollars
Is cryptocurrency necessary in the modern world?
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