There is a big hype when it comes to investing in the crypto markets, the problem is that it might get a bit scary when you're thrown all sorts of terms that you don't know what they mean or maybe don't understand completely. I want to take the time to go through some of these terms and try to have them help out for better investing.
To start off I wanted to go with APR (Annual Percentage Rate) and APY (Annual Percentage Yield) since they are very common to see and at first were one of the terms that most confused me.
First off we need to understand what compound interest is. It is commonly known as "interest on interest" as that is exactly what it is. Let's say you put $100 into an asset that returns 1% interest per month, after a year you would have $112 right? Well if it's compound interest it gets more interesting. Let's say you placed $100 in January on an asset that returns 1% compound interest; by February you would have $101; in March you would get 1% but of the $101 you now have leaving you with $102.01; by April, you'd have ~$103.03 etc. By year you ask? Well with the following formula you can get that:
if you do not care about doing the math you can calculate it here
But whoa what is that??? Let's take a look using the previous case as an example:
- A: The final amount, in our example is the amount of money we would have after a year.
- P: Called the principal which is just a fancy word for the initial value, in our example the $100 we started with.
- r: This is the rate, simply but the percentage; note that in our example we have a 1% rate we would plug the decimal form (1/100) 0.01 into the formula.
- n: Number of times compounded, sounds fancy; in our example we get 1% a month so it would only happen once a month so it's literally just 1 for our n value.
- t: Time periods, wow also sounds fancy; in the example we get 1% every month and we want to see how much it would be in a year so our t's value would be 12.
Placing all this in the formula would look like:
So we would get $112.68 in a year! Lambo incoming.
What You Came For
Sorry for boring you with my maths... But now I will get into the difference between APY and APR. These two values are used to calculate possible rewards especially when it comes to farming and borrow/lend platforms. Note that a token's price can change over time which I will cover in the next post. Anyways, the main difference is that APY takes compound interest into account, this is why APYs will often be higher than APRs. The trick here is that it takes into account that you will be depositing the yield back into the pool. When the token you are rewarded is the same as the token you are farming, sometimes the rewards themselves can compensate the drop in its price. Another thing you can do is swap out the rewards for the token that the farming gives you for the token that has a higher APR.
Something that I like to do is use the APY to calculate my estimated profit and use APR to manage the risk of the token's price dropping. This doesn't mean that one is more important than the other, it's just a means of measyring and doing research on an action you want tot take before hand.