Over the last decade, crypto has grown in popularity around the world. Examples include Bitcoin and Ethereum with their value either rising or dropping depending on the crypto market.
Crytpocurreny, also called ‘crypto-currency’ and ‘crypto’ is a form of currency that is digital or virtual. To secure transactions safely, it uses cryptography.
But, don’t think that crypto (see also ‘Crypto Analysis Tool‘) works like regular, traditional money. Cryptocurrencies do not have a regulating or central issuing authority.
Alternatively, crypto uses a decentralized system in order to record various transactions and generate new units.
Although crypto has become widely used around the world over the last decade or so, many people find it confusing.
Not only is trying to understand the volatile market very difficult (some say impossible), but crypto comes with many acronyms that may as well be another language to many.
One example is APY. This stands for ‘Annual Percentage Yield’ and this is associated with your investment. APY is also evident on savings accounts with banks.
It demonstrates the amount you will generate on your investment over a 12-month period. That is, of course, unless you withdraw funds or transfer money at an earlier date.
Today, we are going to discuss APY and help you understand exactly what it is and how it works in the world of crypto.
By the end of today’s article, you should have a better grip and be in a better position to understand the crypto market.
What Is APY?
APY (Annual Percentage Yield) is basically your annual return on investments. It takes into account compound interest that builds on your first investment.
So, you will earn interest on top of your first-time investment, as well as interest on that interest you accrued.
You may think that the higher an APY value is, the better, but this isn’t necessarily true. If the APY is very high, such as 200% or 300%, it’s best to leave these projects alone.
This is because they are potentially very risky as an investment. In other words, if you’re looking for a stable return on your investments (see also ‘How To Invest $500 Dollars For A Quick Return‘), this sort of number would be too volatile.
So, that is basically how APY works in crypto savings. It also applies to DeFi liquidity pools, too.
Take this as an example – if you invest 1,000 USDT in a crypto interest account at 8% APY, you will earn 1080 USDT after 12 months.
As you can see, knowing your APY can be very important when keeping track of your savings and investments.
Difference Between The Basic Interest Rate And Annualized Percentage Yield
As you now know, APY is in reference to the anticipated rate of a return over one year in a stake or deposit, once you have accounted for compound interest.
Traditional interest rates, however, only take into account the interest that has been accrued on an original stake or deposit.
Therefore, the fundamental difference between interest rates and APY are that APY considers compound interest and its effects, too.
Compound interest is a hugely powerful tool. It allows you to earn additional income over a period of time without touching your savings or stakes.
But, it doesn’t happen overnight. Compound interest is calculated over some time. As the value adds up, it is added to a balance.
So, after a certain period, the interest that has been paid on top of an overall balance also increases.
Here’s an example:
- You stake $1,000 at an interest rate of 12% per annum in January.
- After 12 months, a calculation of the simple interest rate would be 1,000 x 12% = $1,120.
- If you were to stake $1,000 at 12% per annum but with compound interest biannually in the initial six months, you will have 1,000 x 6% = $1,060.
- After 12 months, you would have earned 1,060 x 6% = $1,123.60. You will earn an extra $3.60 from compound interest. So, your APY would equate to 12.36%.
Calculating APY In Crypto
Let’s take a look at how APY works in crypto.
Breaking down your final APY into certain time frames, such as one week, or one month, is pretty straightforward.
Below, we have a simple formula to help you calculate how much interest you would earn every 30 days with 6% APY. This is a 30-day plan and the example uses $1,000 as an initial deposit.
- Interest = (Principal x APY/365) x Period
- Interest = (1,000 x 0.06/365) x 30
- Weekly interest = $4.93
As you can see from this formula, you will receive just $4.93 in interest if you withdraw your funds after one week. This is because the compounding interest effect has not had enough time to “work its magic.”
However, things change if you don’t touch your funds for a year. This is because your interest will build and be added to your overall balance every week.
Eventually, the interest paid will continue to increase over the course of 12 months.
APY Is Very High In Crypto Compared To Traditional Investments: Why?
You will find that APY is typically much higher in crypto than traditional banks. Some reasons for this are below:
- On average, bank savings accounts offer 0.28% because loans are issued at around 3 to 3%. In crypto, APY can reach as high as 6% because loans are typically issued at 5 to 8%.
- There are bigger risks in crypto, but also bigger profits available. This trend is maintained by cryptocurrency exchanges offering loans at similar rates.
- There is more volatility and fewer regulations in crypto. The type of cryptocurrency, however, determines the APY as well as its capitalization.
All investors require a method to compare investment opportunities and calculate the amount of profit that can make.
APY or Annual Percentage Yield helps investors calculate their rate of return whether it be in traditional banking matters or in crypto.
Overall, the higher the APY, the more money an investor will tend to make, but this can also be a sign of high volatility.
By comparing APY options, you can find out the most appealing investments.
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