General

APR vs APY

To illustrate the difference between Annual Percentage Rate (APR) and Annual Percentage Yield (APY), let's consider a simple example. Imagine you have an investment option with an APR of 10%. If you invest $1,000, according to the APR, you would expect to earn $100 over the course of a year, making your total $1,100 at year's end without considering any compounding.

Now, let's apply the concept of APY to the same scenario, assuming the interest compounds monthly. With the same initial investment of $1,000 and an APR of 10%, the interest earned each month would be reinvested, effectively earning interest on the interest from previous months. This compounding effect means that by the end of the year, you wouldn't just have an extra $100 from your investment; instead, you would have approximately $110.47, making your total around $1,110.47. This is because each month, the interest was calculated on a slightly larger amount than the month before, thanks to the reinvestment of earnings.

This example highlights how APY can provide a more accurate and often higher projection of earnings compared to APR, especially in environments where compounding occurs frequently, such as in many DeFi yield farming strategies. APY captures the power of compounding, demonstrating why it's a critical factor for investors to consider when evaluating yield-generating investments.