Annual Percentage Yield (APY)

What Is Annual Percentage Yield?

Suppose one bank pays 5% compounded once a year and another pays 4.9% compounded daily. Which earns more? You cannot tell from the headline rates, and APY answers the question by turning both into the same yearly result.

APY measures what actually lands in your account after 12 months if you leave the interest in place. Each time interest is added, it starts earning interest of its own, a process called compound interest. The more often that happens, the higher the final figure, which is why the 4.9% daily account yields about 5.02%, slightly more than the 5% annual one.

In the United States, the Truth in Savings Act of 1991 requires banks to disclose APY on deposit accounts so that savers compare products on equal terms. Crypto platforms use the same label for staking, lending and vault products, though without the same disclosure rules. Knowing how the figure is built is the best protection against a misleading one.

How to Calculate APY

The formula is APY = (1 + r/n)^n − 1, where r is the nominal annual rate as a decimal and n is the number of compounding periods per year. A 10% rate compounded monthly gives (1 + 0.10/12)^12 − 1, or about 10.47%. Compounded daily, the same 10% becomes about 10.52%.

That small gap explains a common mistake in crypto. Say you stake $1,000 in a pool paying a 10% APR in rewards. If you claim and restake the rewards every day, your APY rises to about 10.52%, which adds roughly $5 over the year compared with simple payouts.

Now add costs. If each restake costs a $2 network fee, daily compounding costs $730 a year to capture $5 of extra yield, turning a $100 profit into a large loss. Auto-compounding vaults exist precisely because they batch many users’ rewards into one transaction, spreading the fee thin enough for compounding to pay.

The lesson reaches beyond crypto. APY assumes compounding is free and the rate never changes. When either assumption fails, the advertised APY overstates what you will earn.

APY vs. APR

APR is the simple annual rate without compounding, while APY is the effective annual rate with compounding. At low rates and infrequent compounding the two are almost identical, but the gap widens quickly as rates rise. A 20% rate compounded daily has an APY of about 22.1%, a difference of more than two percentage points.

Why Is APY Important for Traders?

APY is the fair way to compare yield. A staking reward quoted at 8% APR and a lending product quoted at 8.2% APY may pay almost the same, and only converting both to APY shows which one wins. It also lets you set a yield against a benchmark such as a government bond, so you can judge how much extra you are being paid to take on risk.

Extremely high APYs are usually a warning, not an opportunity. Anchor Protocol paid close to 20% APY on UST stablecoin deposits, funded largely by reserves rather than by borrower demand. When UST lost its dollar peg in May 2022, depositors discovered that the yield had been compensation for a risk that wiped out most of their principal.

Two further limits apply to every APY. It is a nominal figure, so it ignores inflation, and in crypto it is often paid in a token whose price can fall faster than the yield accrues. A 30% APY paid in a coin that drops 50% still leaves you poorer, which is why the currency of the reward matters as much as the rate.

Key Takeaways

• APY is the effective yearly return on money once interest earned on earlier interest is included.
• More frequent compounding and higher rates widen the gap between APY and the simple APR.
• APY assumes the rate stays constant and compounding costs nothing, so fees and falling rates reduce what you actually earn.
• Converting every offer to APY is the only reliable way to compare savings, staking and lending products with different payout schedules.
• A very high APY usually signals high risk, and a yield paid in a volatile token can be erased by that token’s price decline.