While the cryptocurrency sector is undergoing staggering growth and the number of crypto investors is growing by the day, you have to do your homework well before venturing into the fast-growing sector. You will have to be knowledgeable about the nuances of crypto investments for the safety and overall wellbeing of your investments. For a beginner in this sector, the buzzwords can seem rather confusing too. You have to be well versed in the crypto investment terminologies.
What is APR and APY?
The crypto investors need to figure out what is denoted by these 2 terms and the key differences between them, for sure.
APR– It stands for annual percentage rate. It is the yearly funds you earn as the investment interest. Your APR depends on the original investment.
If you invest 1,000 crypto coins with an annual interest rate of 10%, you will obtain 1100 coins by year-end. At the end of the next year, it will be 1,200 coins. However, this calculation excludes any applicable fees. Even then, your investment will have a steady growth rate of 10% per year.
APY– APY is the annual percentage yield. It is the real rate of return obtained from the investment, involving the compound interest. The latter enables you to earn interest on interest.
If you invest 1000 crypto coins and add compounding with 12% interest, along with daily compounding, you get 1,120 coins at year-end. The formula is 1,000 × (1 + 12%) = $1,120.
It is fair to say, APY and APR are nearly the same but the former offers better yield profit because of compounding. As of now, most cryptocurrencies and DeFi tools use APR. You have to deploy compounding manually if getting compound interest is on the agenda. The Crypto investors obtain APY by staking cryptocurrencies or keeping these in savings accounts.
Things that have an impact on Crypto APY
There are a few important metrics that affect APY in the crypto sector directly. These are:
- Inflation- It is loss in value of specific currency subject to time. In the crypto sector, it refers to adding new coins to the Blockchain system. The inflation rate of any network impacts the staking returns.
- Demand and supply- Much like fiat currency, in the crypto sector, supply and demand affects pricing. When the coin supply is abundant, borrowing interest rate is lower and the opposite is also true. The crypto APY is variable and it alters as per the level of demand and coin liquidity.
- Compounding Periods- The time period over which APY is calculated also matters a lot. APY increases when the compounding periods shoot up.
If $100,000 is deposited for monthly compounding at a rate of 5% per annum, the APY is 5.116%. The formula is 100,000 × (1 + 0.05 ÷ 12)^(12).The balance at the year end will be $105,116.
However, for compounding done on daily basis, the ultimate balance will be $105,127. The APY used is 5.126%. The formula is 100,000 × (1 + 0.05 ÷ 365)^(365).
Working of 7-Day APY in crypto
The 7-Day APY is annual revenue, which is earned using 7-day returns. The calculation is simple – finding the net difference in the price of crypto 7 days previously and today and then generating the annual percentage.
There is a simple formula for calculating 7-Day APY:
APY = (X – Y – Z) ÷ Y x 365/7
X = is the final price at the end of the 7th day
Y = is the initial price at the beginning of the 7th day
Z = any fee for the entire week
This calculation helps the investors in understanding a tentative return weekly.
Does APY give an idea about final earnings?
APY shows the profit amount or rate of return or earnings that you can make. Final earnings will vary depending upon the length of time for which you will stake coins. It is the holding period, which decides how much earning takes place.
Calculating APY in Crypto
APY calculates the return rate earned annually as profit on any investment or any amount of money after factoring in compounding.
The formula for APY calculation is as follows:
APY = (1 + r/n) ⁿ − 1
r = annual APR or periodic rate of return
n = number of compounding periods every year
The calculation of APY in crypto is not different from traditional finance as the main purpose is coming up with a percentage yield.
However, depending on the exchanges, there are other methods of calculating APY as well. For instance, Bybit offers flexible staking, with help of which users can stake and unstake tokens anytime for collecting returns they are guaranteed without compounding interest elements. The calculation of APY takes place in a simple interest format. Here daily yields represent the interest rate, which will be deposited in your wallet on the basis of the numbers of tokens that you have staked.
The formula stands as:
Daily yield = Total numbers of tokens staked x (APY for the staked token ÷ 365)
For instance, if you have staked 10,000 USDT at 9% for guaranteed APY, you will be able to collect the nearest integer of 2.5 USDT the very next day. The calculation is: 10,000 x (0.09 ÷ 365) = 2.4657 USDT.
But, if you wish to unstake the tokens after the collection of daily yields, you will not have any yields credited to your account. If there are any changes in the initial staked asset, your daily yield will be impacted.
Crypto Investments Involving APY
There are different ways of investing in your crypto and getting the magical effect of compound interest so that you can grow and multiply your assets.
Crypto Borrowing and Lending
When you are looking for long-term investments in crypto, you will get great mileage from your holdings with crypto lending.
There is not much difference between crypto lending and traditional lending. Paperworks and red tape issues are lesser in crypto. You earn crypto dividends and interest when you give out crypto on any decentralized platform. Interest rates are different – from 3% to 17%.
Suppose you have 10 BTC and you are in urgent need of cash. But you don’t want to sell the coins now as their value will increase by leaps and bounds in the future. You have doubts that if you sell your Bitcoins now, you will have lesser coins when you will repurchase them.
What is the solution then?
There are crypto lending platforms, where you can receive a loan against the 10 BTC. But the trick is that you have to lock in many more numbers of cryptos than the amount against which you are taking a loan.
On paying the loan in full, your additional BTC will be returned. If you are lucky, the BTC will have appreciated.
Crypto lenders are connected to borrowers via lending platforms. This is how the lending process works:
On any lending platform, a borrower requests a loan. Once the request is approved, the borrower will have to stake some cryptos as security for lending. Funding of the loan is done by the lender and he gets periodic interest payments at the agreed APY. Till the tenure of the loan ends, this continues.
On returning the whole loan amount, the borrower gets back the collateralized crypto.
The most important thing in crypto lending is that you have to find a good lending platform – centralized and decentralized platforms.
When you proactively lend your crypto assets for making more crypto, it is known as yield farming. Yield farmers move their assets to different marketplaces so that they get the highest yield and this is their trading strategy. Success comes with constant tracking of APY and taking advantage of various lucrative opportunities. Quite high rates are earned in this when compared to earnings in the bank.
With crypto staking, you can earn high rewards with your crypto once you confirm cryptocurrency transactions on a blockchain network. Actually, you can generate your income on PoS networks, where different stakeholders come for verifying the network. Along with securing the network, you earn cryptos too.
However, you don’t need any kind of special hardware for earning rewards in staking. While staking, your crypto gets locked. You can take it out for circulation for a particular period of time. The supply of the coin is limited effectively, which has a positive impact on its value.
What can you do with the earned interest?
This earned interest is your excellent passive income. This interest goes to your portfolio as profits are earned. Your aim is to earn more interest on that income. This earned interest can be used for further trading. There are many opportunities in the cryptocurrency market for trading derivatives and spot crypto.
Trading spot crypto is purchasing and selling cryptocurrencies at present market rates on any exchange. Trade derivatives are financial contracts, the value of which is based on underlying cryptocurrency.
If you want, you can take the earned interest and use it as a store of value. As a store for value, the crypto will maintain its buying power for use at a later date. Bitcoin is a popular cryptocurrency, which is referred to as ‘digital gold. In derivatives trading, value estimation is done by an underlying asset. The underlying asset might be a cryptocurrency.
Summing it up
It is important that every investor knows some method of comparing investment opportunities. They should also be able to calculate how much profit they have made. Annual percentage yield or APY is the standard calculation of return rate, which is used in crypto and in traditional finance. There is an inclusion of effects of compound interest, which can increase the earned amount. The higher the APY, the higher the money investors can make. You can chalk out the most lucrative investment opportunities by comparing various APY options.